You may be aware of the Qualified State Tuition Program, commonly called a Section 529 College Savings Plan.  With the 529 College Savings Plan you can provide a fund for each child.  Contributions are treated as gifts to the person for whom the plan is established and receive the annual gift tax exclusion of $13,000.  A couple may double this gift amount to $26,000.  A unique attribute of the 529 College Savings Plan is the ability to provide up to five times the annual federal gift tax exclusion amount in a single year.  This allows a single gift of up to $130,000 for each child.

529 College Savings Plan contributions are not tax deductible.  However, all interest and appreciation of the plan’s assets grow tax free until withdrawn.   As long as funds are withdrawn to pay for qualified higher education expenses, the withdrawals are also tax free.  If a designated beneficiary does not use their 529 funds, the donor you may change the beneficiary to a different person, including themselves.  However, if withdrawn funds are not used for higher education expenses, a ten percent penalty plus taxes on all of the funds growth and income will be applied to the withdrawal.

The Coverdell Education Savings Account (ESA) is a less know college savings plan.  Tax-wise, the Coverdell ESA behaves the same as a 529 plan.  However, Coverdell ESAs allow only a $2,000 annual contribution for each beneficiary.  On the positive side, a Coverdell ESA can be set up similar to a Roth IRA providing the “responsible party” with virtually unlimited investment options.  As long as the beneficiary has not reached age 30, the “responsible party” for the Coverdell ESA may change the beneficiary to another person under age 30.

When you purchase EE and I Savings Bonds, they may be redeemed tax free when the bond owner, their spouse or other dependents use these funds to pay for college tuition and fees.  However, due to income phase outs restrictions, full deductibility is lost when a couple has taxable earning above $104,900.

You may also withdraw funds from an individual retirement account, before age of 59 ½, to pay for any family member’s qualified post-secondary education expenses.  The proceeds will be treated as a normal IRA withdrawal with the 10% early withdrawal penalty waived.  .

The Hope Scholarship Credit, now called the American Opportunity Tax Credit (AOC), allows a parent to claim up to a $2,500 annual tax credit for a dependent’s college tuition and mandatory fees.  This tax credit will “phase out” for couples earning above $160,000 per year.  Since this is a tax credit, the full amount (up to $2,500) can be deducted from taxes owed.

The Lifetime Learning Credit can help pay for your own, your spouse, or your children’s education.  You may claim a tax credit of twenty percent of up to $10,000 in combined tuition and mandatory fees for anyone (and everyone) in your family.  Like the AOC, the Lifetime Learning Credit is a tax credit, lowering taxes owed up to $2,000.

The Lifetime Learning Credit’s “phase out” begins at $100,000 per year for joint filers.  Since you cannot claim both the AOC and the Lifetime Learning Credit in the same year, if you qualify for the full AOC, you cannot use this credit.  However, the Lifetime Learning Credit can be used for part time students and for courses to improve your job skill, while the AOC only applies to full time college students.

College expenses will continue to rise.  It is more critical than ever for families to begin early planning to meet these high expenses.  As taxes rise, the tax savings from these programs will become an ever more important piece of your child’s or grandchild’s college education planning.

We will consider four retirement plan options available for the self-employed and small business owner.  Each of the plans provides immediate tax savings on the retirement funds contributed.  The retirement funds also receive tax deferred growth until the funds are withdrawn.

The simplest retirement plan is the IRA.  If you have no company retirement plan and are under age 70 ½ , you may contribute up to $5,000 ($6,000 if you are over age 50) annually to a traditional IRA.  If your taxable income is below $166,000, your spouse may contribute the same amount, if they have no company retirement plan.  This contribution may occur even if your spouse receives no income.  There are no requirements to file any company paperwork with an IRA.  As long as your earned income exceeds your IRA contributions, you may continue IRA contributions until age 70 ½ .

The easiest company retirement plan, for a self employed individual, is the SEP IRA.  Your annual contribution to a SEP IRA is limited to the lesser of 25 percent of your W2 compensation or $49,000 annually.  SEP IRA contributions are tax deductible for the employer and excluded from the employee’s income.  These plans are immediately vested and must apply equally to all employees over age 20, who have been employed for at least three of the past five years.

For high-income, self-employed individuals, a SEP IRA is often the best choice for a company retirement plan.  If your income is below $50,000 or if you expect to have employees, the SEP IRA may not be your best option, as a SEP IRA requires that you provide the same percentage salary contribution for all of your qualified employees.

If your self-employment income is less than $50,000 or if you have employees, the SIMPLE-IRA is worth consideration.  SIMPLE stands for Savings Incentive Match Plan for Employees.  While these plans allow for up to 100 employees, most SIMPLE-IRA plans are used in smaller companies, including single employee companies.

With a SIMPLE-IRA you may contribute $11,500 ($14,000 if age 50 or over) annually.  Additionally, the company pays an employee matching amount of up to 3% for each employee that makes a SIMPLE IRA contribution.  If you are over age 50 and make $100,000 per year, your total contribution could be $17,000.  A SIMPLE-IRA requires that your company submits a (simple) application to the custodial firm.  Employees typically have the same investment options as they would with an IRA or a SEP IRA.

If you are self-employed and earn $100,000 per year or more, you can maximize your tax deferred contributions to with a Solo 401(k) retirement plan.  Solo 401(k) plans are typically established through mutual fund companies, insurance companies and discount brokerage houses.  These plans will have a set up fee, an annual administration fee, and other fees associated with investments and trading.

With a Solo 401(k) plan, you may contribute $16,500 of your W2 income ($22,000 if age 50 or older) plus twenty percent of your net corporate profits, up to a maximum of $49,000 ($54,500 if over age 50).  As an example, if you are over age 50 and your company produces annual income of $120,000, you may contribute $22,000 plus twenty percent of your net income, for a total of approximately $40,000 in contributions, to a Solo 401(k) plan.

For the self-employed or small business owner, there is no “on size fits all” solution to retirement plans.  The best plan will depend upon your annual income as well as the amount of tax deferred savings you desire to contribute each year.  If it is unclear which plan will be the best for you, feel free to contact me or call your financial advisor to determine which retirement plan best fits your requirements.  Regardless of which plan you choose, it is important to start saving now for your retirement, to help insure that you will have financial abundance throughout your retirement.

The press has been full of the fact that the “Bush tax cuts” will expire at the end of 2010.  We have been led to believe that this event will only effect the wealthy, currently being defined as couples earning over $250,000 per year.  While I could make the case that working couples with total income of $250K per year are not always “wealthy”, let’s explore how the expiration of these tax cuts will affect all tax payers, rich and poor alike.

In 2011, when the tax cuts passed in 2001 expire, everyone’s taxes will increase.  What is not commonly known is that, on a percentage basis, the largest increases will be on taxpayers who earn the least.  Here’s why:

In 2010 a couple with taxable earnings of only $25,000 per year pays 10% taxes on the first $16,750 and then 15% on each additional dollar that they earn, up to $68,000.  The total 2010 federal tax bill on $25,000 of taxable income is approximately $2,900.

Since 2011 tax brackets have yet to be published, we will assume no inflation, leaving the 2011 tax brackets the same as in 2010.  In 2011, the 10% tax bracket disappears.  The couple earning $25,000 now pays 15% taxes on every taxable dollar that they earn.  When their tax bill comes due, instead of owing $2,900 to the federal government, they will owe $3,750.  This represents a 30% increase in federal taxes owed.

Now let’s look at a “wealthy” couple, with taxable earnings of $250,000 per year.  In 2010, they are in the 33% marginal tax bracket with a federal tax bill of approximately $60,300.  In 2011, if this couple again has $250K in taxable income, they are now in the 36% marginal tax bracket, with a federal tax bill of approximately $66,600.   The additional $6,300 represents a 10% increase in federal taxes owed..

When the 2001 tax cuts expire, every tax payer will be negatively impacted.   Tax payers with the least income will be hit with the greatest percentage federal tax increase.   Regardless of what the politicians say, the expiration of the 2001 tax cuts will hurt every tax payer, not just the wealthy.

The 2011 tax impact will be even more onerous for Americans who have saved and invested their income. Currently, if you are lucky enough to have long term investments that have increased in value, the government receives a maximum of 15% of your (capital) gain when you sell the investment.   In 2011, the taxes on investment gains will increase by at least 33%, as the long term capital tax rate rises to (at least) 20%.

If you are receiving stock dividends, you currently pay a maximum of 15% federal tax on all of your qualified dividends.  In 2011, these same dividends will be taxed at your ordinary income tax rate, which could be as high as 39.6%.  Thus your dividends will receive tax increases that could be a great as 164% of their current rate.

These tax increases require no action by congress.  Our politicians are also considering numerous new tax increases.  One increase being considered is a European style Value Added Tax (VAT), similar to a sales tax but on a national scale.  However, without any legislative action, the expiration of the 2001 tax cuts will result in a significant tax increase on every tax-paying American.

2010 will be a very important year to pay close attention to your taxes.  If you are planning on retiring, selling a vacation home or any other activity that might have significant tax consequences, visit with you financial and/or tax advisor early in 2010.  Together, you can determine the lowest cost approach, on an after tax basis, to the important decisions that you face in 2010.

What many people are unaware of is that the IRS also offers an “insurance policy” on your Roth conversions.  This insurance can be especially important if you pay taxes on a large amount of converted funds that then proceed to fall dramatically in value, as did the stock market in 2008  This IRS “insurance policy”  is called “Recharacterization.”

Recharacterization allows you undo an IRA to Roth IRA conversion.  If you make the IRA to Roth IRA conversion in January of 2010, you will typically have until October 15, 2011 to undo this conversion through a recharacterization.   Over this 21 month period, if your converted funds fall substantially in value, you would have been better off leaving these funds in the IRA and converting them at their lower value  Recharacterization is the IRS “insurance policy” that allows this.

Here is how recharacterization works:

Let’s assume that you convert $100,000 from your traditional IRA to a Roth IRA in January 2010.  If your marginal tax bracket is 25%, you will be required to pay $25,000 in additional taxes for this conversion.  If the market goes up, the $100,000 grows tax free and you (or your heirs) are never required to pay taxes on this growth.

But what if the market declines, leaving the converted $100,000 with a value of only $50,000 in September, 2011.  You have now paid $25,000 in taxes on an investment that is now worth $50,000.  At this point, your effective tax rate is 50%.  If this happens, you should use the IRS provided “insurance policy” called recharacterization.

Before October 15, 2011, you may put the $50,000 remaining in your Roth IRA back into your traditional IRA account.  You must also file an amended tax return showing this recharacterization.  If done properly, your amended tax return will provide for a refund of the $25,000, in 2010 taxes that was accessed for the Roth conversion.

31 days after you have completed a recharacterization you can once again convert the remaining $50,000 in IRA funds to a Roth IRA.  If you are still in the 25% tax bracket, your tax bill is $12,500 for this new conversion.  If the market skyrockets and the $50,000 grows to $100,000, you will have paid only a 12.5% tax rate on the conversion, based on the new market value.

IRA to Roth IRA conversions have many benefits, as long as you have the financial resources to pay the taxes owed, without having to use IRA funds.  However, the conversion and recharacterization rules are somewhat complex.  If you are exploring a Roth conversion in 2010, be sure to talk to your financial adviser or CPA about the benefits and drawbacks of an IRA to Roth conversion.  After considering all of the facts, if you decide on an IRA to Roth IRA conversion, be sure to re-analyze this decision in September 2011, to see if you should take advantage of the recharacterization insurance policy.

Purchasing a home – Congress has extended the $8,000 refundable tax credit to anyone who closes a “first home” by the end of June 2010.  This “first home” credit applies also to anyone who has not owned a house for the past three years.  If you have a home that you have owned for at least five years, you are eligible for a refundable tax credit of $6,500, as long as your new home costs less than $800,000.  To qualify for either option, income cannot exceed $225,000 for joint tax filers.

A refundable tax credit provides for a full tax refund of either $8,000 or $6,500, even if the taxes that you owe are less than the refund amount.  As an example, suppose that you owe taxes of $5,000 and are receiving a refundable credit of $8,000.  With a refundable tax credit, you pay no taxes at year end and the treasury will send you a check for $3,000.

If you have not owned a home in three or more years or are thinking about moving after living in your home for at least five years, these subsidies can help you buy a new home.  Just be sure to sign a purchase agreement by April 30 and that closing occurs by June 30.

Health Savings Accounts – If you choose a qualified High Deductible Health Plan (HDHP) for your family’s health insurance in 2010, you will be able to make a tax deductible contribution of $5,950 to your Health Savings Account.  Not only are these funds immediately deductible against 2010 income, when you use these funds for future health care, no taxes are due on these funds or their income.

HSAs combine an immediate tax deduction (like an IRA) with the advantage of never paying taxes on these funds (like a Roth IRA), when the HSA funds are used for health care services.  On an after tax basis, HDHP insurance plans, combined with fully funded HSAs are often the most cost effective approach to providing health insurance.

Sales Tax Deduction – For the past few years, Congress has allowed for taxpayers to choose between deducting their state and local income taxes or their annual sales taxes. In states such as Colorado, most people deduct the income taxes.  However, if you are retired or having a low income year, it may be more advantageous to deduct state and local sales taxes instead of income taxes.

My approach is to have a large jar in the pantry into which my wife and I put every receipt with at least $1 in sales taxes.  At the end of the year, you might be surprised to find out how much you pay in sales taxes.  As an example, if you buy $80,000 in taxable items, you pay $6,800 with Colorado’s 8.5% sales tax,.  With Colorado’s 4.64% income tax rate, $145,000 of taxable income is required for the same $6,800 deduction.

IRS provided sales tax tables vastly understate actual sales tax payments.  For the sales tax alternative to succeed, you must save your sales tax receipts.  However, a little effort at the end of the year could save hundreds of dollars in federal income taxes.

Other tax savings approaches include maximizing your retirement plan savings, properly funding your flexible spending account (FSA), gifting strategies, etc.  To get more detail on these and other tax strategies, check out my book, Financial Abundance Guide, which is now available free on my website.

1.    New Car Purchase – If you were unable to take advantage of “cash for clunkers,” but are still planning on a new car purchase, do it now.  If you buy a new vehicle by December 31st, you can deduct state and local sales taxes from your 2009 federal tax return, regardless of whether you itemize or not.  This deduction applies to the first $49,500 of a new car price and phases out for couples earning over $250,000.
2.    Capital Loss Deduction – Determine if you have realized any 2009 capital gains in your taxable investment accounts.  If so, assuming that the taxable accounts have assets that are valued at less than their purchase price, sell enough of these capital loss assets to have a net realized capital loss of $3,000 in 2009.  This $3,000 capital loss will offset other 2009 income.
3.    401(k) and 403(b) Plans – Maximize your 401(k) and 403(b) contributions before year end.  In 2009, the maximum tax deductible contribution for each plan is $16,500.  If you are over age 50, you may make a “catch up” contribution of $5,500 for a total of $22,000.  If it is too late to increase your allocations for 2009, be sure to sign up for the maximum reduction that you can afford in 2010.
4.    Roth IRA Conversions – If your modified Adjusted Gross Income (AGI) for 2009 is less than $100,000, you may convert IRA holdings into a Roth IRA.  While the AGI limitation will disappear in 2010, if your 2009 income is lower than normal, it may be wise to convert some IRA funds before the end of 2009.
5.    IRA Charitable Contributions – For those over age 70½, 2009 is the last year in which you can make direct charitable donations of up to $100,000 from your IRA.  If you withdrew this money and then gave it to a charity, your AGI would increase, which could trigger future Medicare premium increases.
6.    Charitable Gifts –If you are inclined to help those less fortunate than yourself, charitable giving will help reduce your taxes.  Any tangible items that you donate must be in at least “good” condition.   Keep a detailed list of the items, their condition and the thrift store value of each item.
7.    Set up a Donor Advised Fund – If your charitable gifts are in cash, consider establishing a Donor Advised Fund.  You can donate long-term appreciated capital assets to the Donor Advised Fund and receive a deduction for the full value of the asset.  Not only will you receive a charitable tax deduction, you will never pay taxes on your capital gains.
8.    Defer Income – The self-employed and some small business owners can elect to invoice customers in January, so they don’t have to include this income in 2009.  However, this may only be wise if you will be in the same or lower tax bracket in 2010.
9.    Adjust Medical Deductions – Since medical deductions are limited to expenses exceeding 7½ % of income, if you have already had high 2009 medical expenses, get any tests, eyeglasses, prescriptions or dental work that you may require during 2009.  If your 2009 medical expenses are low, hold off on these expenses (if possible) until 2010.
10.    Prepay mortgages and state income taxes – If your mortgage payment is due January 1, paying it by December 31 will allow you to deduct the interest in 2009.  Prepaying your state income tax by December 31 will also allow the amount paid to be deducted in 2009.

There are other methods of reducing your 2009 taxes, such as IRA and HSA contributions, that do not require action by December 31.  However, the actions listed above must be done by December 31 if you wish them to apply to your 2009 taxes.

To view the complete Bankrate.com article please click   Abundance or Scarcity It’s Up To You

Did you know that there is a simple, easy and free way to set up your own “charitable foundation?”  This “charitable foundation” can be used to make tax-advantaged gifts to all of your favorite charitable organizations.   If you are planning on making charitable year end gifts to claim a 2009 tax deduction, now is the time to establish your “charitable foundation” by setting up a Donor Advised Fund.

Donor Advised Funds are qualified, private, non-operating foundations that pool their donations and allow you to select your favorite charities for gifts. The gifts that you make can be as little as $50 and can be given to any qualified charitable organization.

You may use a Donor Advised Fund to gift appreciated stock to many charitable organizations.   As you are probably aware, giving appreciated long-term capital gain stock to a charitable organization provides a double tax savings.  You receive the full market value of the appreciated stock as a charitable deduction, plus you pay no capital gains taxes on the stock’s appreciated value.

However, giving small amounts of stock directly to multiple organizations can be both cumbersome and time consuming.  Donor Advised Funds solve this problem.  A Donor Advised Fund account can be established at Schwab, Vanguard or Fidelity as well as at many other brokerage firms. Once the account is established, you may donate appreciated long term stock to the account and take the full market value of the stock as a 2009 tax deduction.  If you do not gift the full value of your donated stock during 2009, you still get the deduction for the stock’s full value in 2009 plus the remaining funds can be gifted at any time in the future.

Let’s look at an example of how a Donor Advised Fund works. Suppose that you bought 100 shares of IBM stock in July 1993 at $10.50 per share. You now wish to sell this stock, but you would prefer not to pay the long term capital gains taxes on your profit.

Today, IBM is trading at approximately $126/share. Your $1,050 investment in 1993 is now worth $12,600.  If you donated this stock to your Donor Advised Fund, you would get a 2009 charitable deduction of $12,600.  You would also avoid the requirement of paying capital gains taxes on the $11,150 capital gain.

If you wished to continue to hold IBM, you could gift the stock to your Donor Advised Fund and immediately buy 100 shares of IBM stock.  This approach provides a new cost basis of $12,600.  Since you are gifting the IBM stock and not selling it, the “wash sales” rules do not apply. This approach allows you to increase the basis of your stock while dramatically increasing the after tax value of your charitable gift.

Donor Advised Funds are similar to having your own charitable foundation.  However, charitable foundations have high overhead and legal expenses that make them impractical for most people.  With a Donor Advised Fund, you have your own “mini charitable foundation” with none of the headaches.  If this approach seems appropriate for you, contact your brokerage firm today to get your Donor Advised Fund account set up before the end of 2009.

With a traditional IRA, contributions can only be made if you are under 70½ years old and you and/or your spouse have earned income. The maximum contribution is the lesser of $5,000 ($6,000 if over age 50) or the total amount that you and/or your spouse earned.  If you have a qualified retirement plan, the full amount can only be contributed if your Modified Adjusted Gross Income (MAGI) is no more than $55,000 as a single tax payer or $89,000 as a joint filer.

With a Roth IRA, your Adjusted Gross Income (AGI) must be less than $105,000 as a single filer or $166,000 as a joint tax filer plus you and/or your spouse must have earned income.  Like a traditional IRA, the maximum contribution is the lesser of $5,000 ($6,000 if you are over age 50) or the total amount that you and/or your spouse earned. If deductible IRA contributions are made, the amount that can be contributed to a Roth IRA is further reduced by the amount contributed to a deductible IRA.

The decision on which IRA to use is sometimes obvious:

1. A single filer with an AGI over $105,000 or a joint filer with an AGI over $166,000 who is not covered by a retirement plan can only fund an IRA.
2. If covered by a company retirement plan with a MAGI of over $89,000 but less than $166,000 as a joint filer or over $55,000 but less than $105,000 as a single filer, only a Roth IRA can be fully funded.
3. If you reach 70 ½ and have earned income, only a Roth IRA can be funded.
4. When saving to buy a first home, only with a Roth IRA can up to $10,000 of growth and income plus all contributions be withdrawn, tax and penalty free.

The following are more subtle advantages of Roth IRA plans:

1. For those under 40, the tax free growth combined with the tax free withdrawal of the funds (after age 59½), typically make the Roth IRA a better investment.
2. If funds are required before reaching age 59½, a Roth IRA allows the withdrawal of all contributions, with no taxes or penalty on this withdrawal.
3. For older individuals, a Roth IRA is an excellent way to pass funds to younger generations. The younger recipient may allow these funds to continue to grow tax free by withdrawing inherited Roth funds tax free over their lifetime

When none of the above apply, the decision of funding a Roth IRA or a traditional, deductible IRA must be made by analyzing your current tax bracket, what you believe will be your future (retirement years) tax bracket and whether you expect to consume the retirement funds or pass them to future generations.  If you need help making this decision, consult with your financial planner or tax adviser.

When IRA funds are converted to a Roth IRA, taxes must be paid on the amount of (pre-tax) IRA contributions that are converted.  However, another “gift” from the Pension Protection Act of 2006 is the ability to delay this tax liability on funds converted in 2010.

In 2010, if you convert $100,000 of taxable assets from your IRA to your Roth IRA, you may choose to pay taxes on an additional $100,000 of income for tax year 2010.  However, you also have the option of paying no additional income taxes on the converted amount in 2010.  Instead, you may pay income taxes on ½ ($50,000) of the income in tax year 2011 and on ½ in tax year 2012.

After 2010, you may continue to convert IRA funds to Roth IRA funds, regardless of income.  However, from 2011 on, taxes on the converted taxable amount must be paid in the tax year during which the conversion is made.

Are there any reasons to not use the three year option for a 2010 Roth conversion?   An obvious reason would be if you have very little income in 2010 and expect significantly more income in 2011 and 2012.  A less obvious reason may be the possibility of future federal income tax increases.

The current administration has proclaimed that it will raise taxes on the “rich,” which it defines as couples with incomes of $250k or more.  One way this will be accomplished is by allowing the current “tax cuts” to expire at the end of 2010.  When these tax cuts expire, income taxes on all income level will rise in 2011 and beyond.

Since 2010 is an election year, congress may not be anxious to pass additional tax increases in 2010.  However, with our enormous and increasing budget deficit, a tax increase in 2011 appears likely. Depending upon your expected income in 2010 – 2012, you could pay less in taxes on your IRA to Roth IRA conversion by declaring the full amount of income in 2010, especially if income taxes increase dramatically in 2011 and beyond.

If you are considering retirement in the near future, it may be beneficial to retire at the end of 2010.  This could allow you to convert a substantial amount of IRA savings into a Roth IRA.  With the three year option, the Roth conversions would be taxed in 2011 and 2012, when work related income has ceased.  This approach could minimize the amount of taxes owed on the Roth IRA conversion.

Do not do an IRA to Roth IRA conversions without having enough funds, outside of the IRA, to pay the taxes owed.  If the taxes are taken out of the IRA, advantages of a Roth conversion will be substantially lost.  When IRA funds are used to pay the taxes owed on the conversion: 1) taxes are paid on funds being used to pay taxes 2) If you are under 59 ½, a 10% penalty will be assessed on IRA funds that are used to pay taxes and 3) the tax deferred and tax free account funds are reduced in value by the amount of taxes and penalties paid.

2010 provides an opportunity for millions of new taxpayers to consider the advantages of converting IRA funds into a Roth IRA.  If you are unsure of whether this conversion would be beneficial, talk to your financial planner or tax account and ask them to help you make this determination.