Tax News

INSIDE WASHINGTON

Ø Before the year is done, you can expect Congress and the President to debate a wide range of tax-cut plans. Among the items likely to be considered are:

· Reforming Social Security

· Reforming Medicare

· Expanding Medicare coverage (see note below)

· Improvements to healthcare coverage

· Expanding Education IRAs

· Expanding the ROTH IRAs

· Modifying the student loan interest deduction provisions

· Extending the income exclusion for employer paid tuition

· Expanding the employer aid tuition exclusion to cover graduate education

· Increasing the federal estate tax lifetime exemption

· Increasing the percentage of health insurance premiums that can be deducted by self-employed taxpayers

· Expanding the Medical Savings Accounts

Commentary: If things "inside" Washington run according to form, Congress and the President will not get down to serious negotiations until later this Summer or early Fall. In the end, all sides may be restricted in what they can propose this year because of the increased Defense Department expense associated with the war in Yugoslavia. Now that the bombing has stopped, you can expect a debate over what financial commitment the United States should make towards peace keeping forces and rebuilding the war-damaged country. We will be monitoring the tax changes very carefully.

Ø President Clinton has proposed offering prescription drug coverage to all 39 million Medicare beneficiaries and finance it with a "modest" premium. The White House plan will launch what can best be described as the most far-reaching domestic policy debate in Congress this year. A federal subsidy and a premium charge to recipients would finance the plan. A beneficiary's cost would be significantly below the average $90-a-month premium charged by private insurers. Nearly two-thirds of Medicare beneficiaries have some drug coverage, but the number of people covered has declined as drug costs have escalated.

The prescription-drug plan will be part of a broader Medicare package proposed by President Clinton. Clinton's goal is to extend the solvency of the entitlement program beyond 2015 when some experts have predicted that the program faces insolvency.

Ø President Clinton has requested that the Labor Department write new regulations letting the 50 states provide unemployment benefits to parents of newborn or newly adopted children who choose to take leave as provided under the 1993 Family and Medical Leave Act. Reports "inside" Washington suggest that this proposal faces significant obstacles, because the states will be reluctant to draw on accounts for people who are out of work. The 1993 law guarantees up to 12 weeks of unpaid leave. The Clinton proposal would make unemployment pay possible.

Ø An audit of the IRS conducted by the General Accounting Office (GAO) found the tax agency was unable balance its own books. The GAO report found that:

· At least $17 million was paid out by the IRS in fraudulent and inappropriate refunds in the first nine months of 1998.

· The IRS sometimes duplicates refunds or fails to compare tax returns with W2 data before a refund is sent out.

· The IRS used improper paperwork to keep track of such items as a Chevrolet Blazer, a $300,000 laser printer, laptop computers, televisions, VCRs and fax machines. Most of these were found to be IRS computer errors and not theft. The Blazer, for example, was returned to a leasing company but never taken off the IRS books.

· The IRS is guilty of poor computer security, including controls on access to sensitive taxpayer information.

REAL ESTATE MAILBAG

Ø The most exciting development in the real estate/tax area during the past two years has been the legislation allowing the sale of a "principal" residence with no tax gain provided certain gain limits are not exceeded. The $250,000 (single taxpayer)/$500,000 (joint taxpayers) exclusion rules have become overwhelmingly popular to homeowners and tax professionals alike. Be sure to consult with your tax professional before placing your home on the market in order to be certain you will qualify for the gain exclusion. Also, keep in mind that the rules have changed in your favor - you no longer have to buy a replacement home and you can use this rule over and over again!

Ø When most taxpayers start looking for a home loan, their first concern is the interest rate. The mortgage rate represents the single most expensive part of your decision to buy a home. Over a 30-year period, you are likely to pay more in interest than you will for the house itself. There is one reason why there is such a range of interest rates available - POINTS. Points represent a one-time fee paid to a lender. The more points you pay at closing, the lower the interest rate available. Points are the price you, the borrower, pay for obtaining a certain interest rate. As a form of interest, a point is equal to 1% of the loan amount. If you agree to pay one point on a loan of $150,000, the charge is $1,500. If you pay three points, the charge is $4,500.

There is no simple answer to the question - should I pay more points to get a lower rate? No two taxpayers may find themselves in the same situation with the same right answer. Sometimes, it pays to pay more at the outset to gain more over the long term. Let’s use an example with real numbers to illustrate the point: You are looking to borrow $100,000 to purchase a new home. After reviewing the best available home mortgage interest rates in your area, you find the following proposals available to you: 6.5% with 2.25 points ($2,250), 6% for 5.75 points ($5,750), or 7% for 0 points. Which is the best offer for you?

One difference is the out-ofpocket cash. What about the difference in your monthly payments? The 6.5% loan will cost you $632 a month for principal and interest. The 6% loan payment would be $600. At 7%, the monthly rate goes up to $665. The monthly savings to you with the 6% rate instead of the 6.5% rate are $32 a month. But, the out of pocket cost to you to get the 6% rate over the 6.5% rate is $3,500. If you went with 7% rate, you will pay $33 than at the 6.5% rate and $65 more than the 6% rate but you have no points to pay.

Which option is right for you? The answer is - it depends. You and your tax professional are in the best position to come up with the correct answer for your situation. Among the issues your tax professional will analyze are 1) what can you afford to spend each month, 2) how long are you planning to keep the mortgage and 3) how difficult will it be for you to pay the points?

One of the factors your tax professional will determine for you is your "break-even point." The "break-even point" is the month when you will have saved exactly as much in monthly payments as you spent at the closing. One method frequently used by tax professionals (after an in-depth interview with you) is to divide the cost of the points you would pay at closing by the potential monthly savings. Applying this test to the facts presented above, you will find the difference in points between the 6% loan and the 6.5% loan is $3,500. $3,500 divided by the $32 per month savings = 110^th payment. 110 equals nine years and two months. If you plan on living in your new residence (or keeping the mortgage) for longer than that period, you will recoup your initial outlay - so here the answer would be to consider the lower rate with more points being paid. If you don't plan on living there very long, it might make more sense to pay a higher rate and pay fewer points up front.

Sound complicated? Your tax professional can not only guide you through this very important decision – but can save you money as well. It pays to seek tax advice before you act!

Ø There is a little-known federal housing rules that allows parents to purchase condos and houses for their college-attending children with a down payment as low as 3%. The child and the parents co-own the property so the parents can take a deduction for the interest and real estate taxes paid. Under the Federal Housing Administration program, nicknamed "kiddie condos," students eventually graduate from college with a better understanding of real estate and investing (we hope). In many cases the savings (mortgage expense vs. college charges for housing) are well worth the investment. Experienced real estate agents should be familiar with the FHA program. Consult with your tax professional to see if this strategy is for you.

NEW IRA POLICIES MAY MEAN BIG I SAVINGS

In the words of The Wall Street Journal "one-by-one, major players in the retirement plan market are adopting policies that could save people thousands, if not millions of dollars through the years." By allowing people who inherit individual retirement accounts to name their own beneficiaries, they are extending the potential life of these tax-deferred accounts by 10,30 or in some cases even 70 years. That's good news for the generation just starting to inherit IRAs from their parents and grandparents, and even better news for people who will inherit from them.

With IRAs now the single largest asset owned by many Americans, the impact of the changes is substantial. The policy changes also apply to 401(k) plans as well as other "qualified plans.” Consider if you will what happens to an IRA worth $1 million if someone who inherited the IRA dies with 10 years of distributions remaining. One possibility is that the IRA would terminate and all remaining assets distributed. The potential income tax bill could exceed $350,000 plus a potential estate tax liability of up $130,000 if the beneficiary was someone other than a spouse. Wow!

Now, one school of thought circulating within the IRA investment community is that it is possible for the IRA to continue on the original distribution schedule. The income-tax bite would be spread over 10 years as the IRA continued to grow. It should be noted there is disagreement regarding this approach among some of the biggest players in the IRA market and the IRS has offered little guidance to date. Vanguard Group, BankBoston and Citigroup's Salomon Smith Barney, have been routinely allowing IRAs to continue after the death of the beneficiary. One word of advice here: shop for the IRA provider who offers the best long-term planning opportunities. Be sure to consult with your tax professional to review the long-term and long-lasting implications of your retirement investment.

DID YOU KNOW?

· that computers are used by 63% of adults; 26% use one at home and at work. The average weekly computer use is 15 hours with six of those on the Internet.

· May 1999 unemployment dropped to 4.2%, matching the 29-year low reached in March. Economists cite a record ninth year of economic expansion, a tight labor market and low inflation.

· Women are more likely than men to fall into poverty as they age, to need long-term health care and to spend significantly more of their retirement money on out-of-pocket health costs.

· Normally, attorney's fees for divorce proceedings are not deductible. But, the portion of the fees that relates to advice on the tax aspects of alimony and child-support payments may be deductible.

· Effective with this tax-filing season, taxpayers were eligible to pay their federal taxes by credit card. The heftiest credit card payment to date is about $300,000. Over 20 taxpayers have charged $100,000 or more.

· Workers are retiring younger, the Labor Department says. The average age in the US was 62.2 for men, 62.7 for women, between 1990 and 1995. That is down from 64.1 and 65.3 respectively, between 1965 and 1970.

Summer 1999 Client Newsletter

INSIDE WASHINGTON

REAL ESTATE MAILBAG

NEW IRA POLICIES MAY MEAN BIG I SAVINGS

DID YOU KNOW?