Student Loan Interest Rates Set To Rise On July 1st

by Andrew D. Schwartz, CPA

Last month, Congress passed the Deficit Reduction Act of 2005, which includes a provision dramatically cutting the amount of the government's student loan package by $13 billion.  This change affects anyone who will take out student loans in the future, as well as those who have student loans outstanding but haven't yet consolidated them.

Since these cuts reduce subsidies available to student loan lenders, interest rates are on the rise.  Effective July 1st, the rate for Stafford Loans jumps from 4.7% to 6.8%, and the fixed rate on PLUS loans increases to 8.5% from as low as 6.1%. 

There are quite a few changes to the loan consolidation rules as well.  Not only will rates increase substantially on July 1st, you'll no longer be able to include certain types of student loans, including Direct Loans and FFELPS, when you consolidate. 

Student Loan Strategies

If you currently have outstanding student loan debt, now is the time to assess your student loan portfolio and consider the options available to you through June 30th, including consolidation.  A good source of information is Sallie Mae and AAMC.org.

Consolidating generally makes sense for people with student loans. When you consolidate, you reduce the number of loans outstanding and the number of payments you need to make each month, making it easier for you to manage your student loan portfolio. You can also take advantage of desirable options that reward you with a lower interest rate for making your monthly payments automatically and consistently making your payments on time.

If you currently have a child in college, make sure to complete the FAFSA annually, and consider taking out a Stafford Loan each year. As long as you submit the FAFSA form, you're generally eligible to borrow $2,625 for your child's freshman year, $3,500 for the sophomore year, and $5,500 for the final two years. Most students are eligible for a Stafford Loan (up to a certain limit) regardless of income, and many qualify for a “subsidized” version of this student loan – meaning the government pays the interest until the student’s graduation. 

One positive outcome of the Deficit Reduction Act of 2005 is that the maximum Stafford Loan increases from $2,625 to $3,500 for first-year students and from $3,500 to $4,500 for second-year students, effective July 1, 2007.

Saving For A Child's Education

Do you have a child who will attend college in the future? Rising student loan interest rates provide an extra incentive for you to save more money towards your child's education.

What is the best way to save for a child's education these days? With all the options available to you today, it's important to understand the basics:

• 529 Plans.  With these state sponsored education savings plan, you purchase into a managed investment portfolio based on when your child will attend college. Amounts contributed grow tax-deferred, but since the post-2010 rules have not yet been determined, withdrawals from a 529 Plan to pay for college tuition and fees might end up being taxed at your child’s rate starting in 2011. For 2006, you can contribute up to $12,000 per child into a 529 plan. Or, you can make five years worth of contributions, up to $60,000, all in one year. Just make sure to file a Gift Tax return (Form 709) electing to spread your 529 contributions over five years.

• Pre-paid Tuition Programs.  If you’re concerned that the cost of college will rise quicker than your investment portfolio, take a look at pre-paid tuition programs. Many states offer these college savings programs on behalf of colleges and universities within their state. Or you can check out the Independent 529 Plan, which is a national pre-paid tuition program representing approximately 250 schools throughout the country.

• Coverdell Education Savings Accounts.  Formerly known as Education IRAs, you can contribute up to $2,000 per beneficiary per year into an ESA. You’re not allowed to contribute into an ESA if your adjusted gross income exceeds $220,000 ($110,000 if single). Amounts contributed grow tax-free, as long as the money is used for your child's K-12 or college tuition or other allowable education expenses. Unlike 529 Plans, the tax rules for ESAs won’t change in 2010 when the 2001 Tax Act sunsets.

• U.S. Government Bonds.  Another way to save for a child's education is with EE Bonds or I Bonds. Both of these bonds can be purchased at a bank or from TreasuryDirect.gov. I-Bonds are currently yielding 6.73%. As long as your child's name isn't on the bond, the interest isn't taxable to you provided the total bond proceeds don't exceed the amount spent for tuition and fees. This tax break has a pretty low phase out - $121,850 for married couples and $76,200 for single individuals in 2005.

• Two Tax Credits.  If you're paying for a child's tuition out of your current earnings, don't overlook the Hope Scholarship Credit, which saves you up to $1,500 per year in taxes each of the first two years of college. Another option is the Lifetime Learning Credit, which saves you up to $2,000 in taxes per year. Both of these credits phase out this year once your income exceeds $107,000 if married or $53,000 if single.

• Employ Your Child.  If you have an unincorporated business, you can pay your child up to $5,150 (in 2006), deduct his or her wages, and your child won't pay any income taxes provided the wages are the only income earned during the year.  Wages paid to your child are also exempt from social security, Medicare, and unemployment taxes. You can even contribute up to $4,000 from those wages into a Roth IRA each year, which would be available to pay for your child's college expenses, fund first time homebuyer costs, or grow tax-free over the next fifty years or more.

Higher Rates Are Here To Stay

It looks like the days of low interest rates on your student loans end on July 1st. Consolidating your loans by June 30th, and taking advantage of the strategies described above to save for your child's education, can help cushion the blow.

Questions about student loans?  Please e-mail us your questions at studentloans@mdtaxes.com.

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Track Your Professional Expenses To Save Taxes

by Andrew D. Schwartz, CPA

It’s fair to say that everyone wants to save taxes.  One way to cut your tax bill is to deduct your unreimbursed professional expenses on your tax return.  On the surface, these IRS rules are pretty straightforward.  For an expense to be deductible, it must be both "ordinary" and "necessary" in connection with your profession.

Let's say that you buy a Palm Pilot or PDA that you use to keep your schedule and your list of contacts.  I would say that qualifies as ordinary and necessary.  But what if you go to the Coach Store and purchase a leather carrying case for your PDA?  Even though you might consider that purchase ordinary and necessary, the IRS would probably disagree.

On our site, we've posted a listing of professional expenses commonly incurred by your colleagues. You might want to keep this information handy when reviewing your check register and credit card statements searching for all your deductible professional expenses incurred during the year.  A link to our listing of professional expenses common to people in your profession is available on our home page.

Set Up A System

Setting up a system to keep track of your professional expenses throughout the year will save you taxes.  Here are a few suggestions:

• Use Quicken or Microsoft Money to track all of your expenditures throughout the year.  Both of these personal finance programs allow you to assign a category for each check written and credit card purchase made.  At the end of the year, simply print out a report that includes all your professional expenses to deduct on your tax return.

• Use a Separate Credit Card For Business Related Purchases.  This allows you to easily compile all your professional expenses made during the year, since all your deductible expenditures will be reflected on your 12 credit card bills.  Or even better, use a credit card from one of the companies that sends their customers an annual summary of their activity for the year.

• File Your Receipts In a Folder or Envelope.  At the end of the year, all you need to do is tally up your receipts to figure out the professional expenses you can deduct.

• Download Our Excel Spreadsheet available at our home page which lets you easily track your professional expenses on a monthly basis.

Deducting Your Professional Expenses

How you deduct your professional expenses depends on how you are compensated.

• If you’re compensated as an employee (taxes are withheld from your pay), you’re required to deduct your professional expenses as a miscellaneous itemized deduction on your Schedule A. To do so, you’ll need to complete and attach a Form 2106 or 2106-EZ, Un-reimbursed Employee Business Expense, to your Form 1040.  Don’t forget that your miscellaneous itemized deductions are only allowable to the extent they exceed 2% of your adjusted gross income.  If you're paid as an employee, you're almost always better off to have your employer pay your professional expenses for you, since they will be paid with pre-tax dollars.

• If you’re compensated as an independent contractor (NO taxes are withheld), you’ll deduct your professional expenses directly against your income on a Schedule C or Schedule C-EZ, Profit or Loss From Business.  Here’s where your professional expenses give you the biggest bang for the buck.

• If you’re compensated as both an employee and an independent contractor, you’ll need to determine whether to reflect a specific expense on the Schedule C or the Form 2106. Items specifically related to your income as an independent contractor, such as malpractice insurance and directly related auto mileage, will be deducted directly against that income. Other items, such as job search expenses, which are more closely related to your employment, should be reflected on the Form 2106.

The AMT

What does the Alternative Minimum Tax (AMT) have to do with professional expenses?  While professional expenses reported on the Schedule C are not limited by the AMT, there's a good chance that your un-reimbursed employee business expenses reported as a miscellaneous itemized deduction might trigger the AMT - essentially limiting the taxes you'll save.

To avoid the AMT, either have your employer reimburse you for your professional expenses, or try to have enough independent contractor income each year so you can claim them all on your Schedule C.

Avoid the Spend to Deduct Mentality

While keeping track of the money you spend during the year will save you taxes, spending money for the sole purpose of padding your deductions is generally never a good idea.  As my tax professor told my class on many occasions, “Don’t let the tail wag the dog” when it comes to deductions.

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Tax Breaks For Homeowners Kick In

by Andrew D. Schwartz, CPA

The Energy Tax Incentives Act of 2005 was created to offer Americans tax breaks in 2006 for being energy efficient. So, if you're environmentally friendly, some of the provisions of this new law will save you some taxes

Energy Tax Cuts Effective in 2006

• Energy Efficient Home Improvements: You can now qualify for a tax credit equal to 10% of the money spent on the installation of certain energy efficient improvements to your principal residence, including insulation and exterior windows, doors, and skylights. You can also take a tax credit for "qualified energy property" including up to $50 spent on circulating fans, $150 on furnaces or hot water boilers, and $300 on heat pumps, water heaters, and central air conditioning. The credit applies for purchases made during 2006 and 2007, and is limited to a lifetime max of $500 per dwelling, with no more than $200 of the credit to be taken for replacement windows.

• Energy Efficient Appliances: The law provides manufacturers with a tax credit ranging from $50 to $200 per unit for each energy efficient dishwasher produced in 2006 and 2007, and for each washing machine and refrigerator produced between 2005 and 2010. If purchasing an energy efficient appliance is in your plans, make sure the manufacturer passes this tax savings on to you.

• Energy Efficient New Home: Contractors are eligible for a tax credit of up to $2,000 for each new (or significantly rehabilitated) home "substantially completed" and sold during 2006 and 2007, provided the home meets certain energy savings criteria. If you're in the market for a brand new home, make sure the builder passes this lucrative tax break on to you.

• Energy Efficient Commercial Improvements: If you own a commercial building or condo, you're eligible to claim an immediate deduction of up to $1.80 per square foot (versus depreciating the costs incurred over 39 years) by making major energy saving improvements to your building's lighting, hot water, and HVAC systems during 2006 and 2007. Upgrading insulation, metal roofs, and exterior doors and windows also counts towards this deduction.

Hybrid Vehicles

There is also a tax credit available to people who purchase hybrid vehicles.  This credit, which replaced the $2,000 "Clean-Fuel" deduction, ranges from $650 to $3,400, depending on the vehicle, for purchases made between 2006 and 2010.

There is a catch, however.  The allowable credit decreases once a certain number of each hybrid model is sold each year.  So there is an incentive to purchase your hybrid vehicle early in the year.  The dealer should be able to tell you how much of a tax credit you'll be eligible to receive.

Tax Simplification Was Thrown Out the Replacement Window

Congress didn't have tax simplification in mind when they came up with these rules.  Even so, there should be enough information available, especially from manufacturers, retailers, and contractors trying to get you to purchase products or services from them, that you should be able to determine when you're eligible for these tax breaks.

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TAX AND FINANCIAL PLANNING CALENDAR FOR MARCH, 2006

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2005 & 2006 TAX FACTS

• For 2005, the standard deduction for a single individual is $5,000 and for a married couple is $10,000. A person will benefit by itemizing once allowable deductions exceed the applicable standard deduction. Itemized deductions include state and local income taxes (or sales taxes), real estate taxes, mortgage interest, charitable contributions, and unreimbursed employee business expenses. Check our list of deductible expenses common to healthcare professionals for more info.
• For 2005, the personal exemption is $3,200. Individuals will claim a personal deduction for themselves, their spouse, and their dependents. 
  
• The maximum earnings subject to social security taxes is $94,200 for 2006, up from $90,000 in 2005.
  
• The standard mileage rate is $.485 per business mile as of September 1, 2005 (after being $.405 per mile through August 31, 2005), and will then be $.445 per mile for 2006.
  
• The maximum annual contribution into a 401(k) plan or a 403(b) plan is $15,000 for 2006.  And if you'll be 50 or older by December 31, 2006, you can contribute an extra $5,000 into your 401(k) or 403(b) account this year.
• The maximum annual contribution to your IRA is $4,000 for 2005 and 2006.  And once you turn 50, you can contribute an extra $500 into your IRA for 2005 and an extra $1,000 for 2006.  You have until April 15, 2006 to make your 2005 IRA contributions. 

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Tax and financial planning calendar for March, 2006


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