The Ultimate Tax Planning Guide

Gleason Tax Advisory
Group, LLC
Joseph Gleason
President
12211 W. Bell Rd.
Suite #203
Surprise, AZ 85378
(623)815-9100
joe@gleasontax.com
www.GleasonTax.com
The Ultimate Tax Planning Guide
February 03, 2011

Page 1 of 33, see disclaimer on final page
Table of Contents
Tax Planning for Income ........................................................................................................................................5
What is tax planning for income? ..................................................................................................................5
Why is it important for you to understand the concept of income? ............................................................... 5
Why is it important to know how to generate tax-free income? .................................................................... 5
How can you shelter earned income from taxes? .........................................................................................5
Why should you be aware of strategies to defer taxes? ............................................................................... 5
What are some other tax-advantaged strategies? ........................................................................................5
How can you shift income and tax to others? ............................................................................................... 6
What about Social Security benefits? ........................................................................................................... 6
Generating Tax-Free Income .................................................................................................................................7
What is generating tax-free income? ............................................................................................................ 7
How can IRAs be used to generate tax-free income? .................................................................................. 7
529 plans and Coverdell education savings accounts ..................................................................................7
How can bonds be used to generate tax-free income? ................................................................................ 7
How can life insurance be used to generate tax-free income? .....................................................................8
How can qualified small-business stock be used to generate tax-free income? .......................................... 9
How can the gain on sale of your personal residence generate tax-free income? ....................................... 9
Other Tax-Advantaged Strategies ......................................................................................................................... 10
What are some other tax-advantaged strategies? ........................................................................................10
Why should you create passive income to take advantage of passive losses? ........................................... 10
Why should you engage in year-end tax planning? ......................................................................................10
Why is it useful to generate capital gains? ................................................................................................... 10
How is investing in real estate beneficial, from a tax standpoint? ................................................................ 10
What is the tax advantage to receiving annuitized payments? .....................................................................11
Tax Planning Tips: Life Insurance ........................................................................................................................ 12
Life insurance contracts must meet IRS requirements ................................................................................ 12
Keep in mind that you can't deduct your premiums on your federal income tax return ............................... 12
Employer-paid life insurance may have a tax cost ...................................................................................... 12
February 03, 2011

You should determine whether your premiums were paid with pre- or after-tax dollars ..............................12
Your life insurance beneficiary probably won't have to pay income tax on death benefit received ............. 12
In some cases, insurance proceeds may be included in your taxable estate ..............................................13
If your policy has a cash value component, that part will accumulate tax deferred ..................................... 13
You usually aren't taxed on dividends paid ................................................................................................. 13
Watch out for cash withdrawals in excess of basis--they're taxable ............................................................ 13
You probably won't have to pay taxes on loans taken against your policy .................................................. 13
You can't deduct interest you've paid on policy loans ................................................................................. 14
The surrender of your policy may result in taxable gain .............................................................................. 14
You may be able to exchange one policy for another without triggering tax liability ....................................14
When in doubt, consult a professional .........................................................................................................14
Tax Planning Tips: Disability Insurance .................................................................................................................15
Individual disability income insurance ...........................................................................................................15
Employer-sponsored group disability insurance ........................................................................................... 15
Benefits under a cafeteria plan ..................................................................................................................... 15
Group association disability insurance ......................................................................................................... 15
Government disability insurance ...................................................................................................................16
Is it wiser to buy disability coverage with pretax or after-tax dollars? ........................................................... 16
Tax Planning for Annuities .....................................................................................................................................17
Taxation of premiums ................................................................................................................................... 17
Tax-deferred growth ..................................................................................................................................... 17
Taxation of premature withdrawals ...............................................................................................................17
Taxation of scheduled distributions .............................................................................................................. 17
Taxation of lump-sum distributions ............................................................................................................... 17
Tax Planning for the Self-Employed ...................................................................................................................... 18
Understand self-employment tax and how it's calculated ............................................................................. 18
Make your estimated tax payments on time to avoid penalties .................................................................... 18
Employ family members to save taxes ......................................................................................................... 18
Establish an employer-sponsored retirement plan for tax (and nontax) reasons ......................................... 18
Take full advantage of all business deductions to lower taxable income ..................................................... 19
February 03, 2011

Deduct health-care related expenses ........................................................................................................... 19
And starting in 2014 ......................................................................................................................................20
Tax Tips: Health Insurance ....................................................................................................................................21
You don't include employer-paid premiums in your income ......................................................................... 21
What if your employer reimburses you for your premiums? ......................................................................... 21
In most cases, you won't be able to deduct the premiums you pay ..............................................................21
If you're self-employed, special deduction rules may apply ..........................................................................21
Your health insurance benefits typically aren't taxable ................................................................................. 22
Tax Tips: Long-Term Care Insurance ....................................................................................................................23
You may be eligible for an income tax deduction ......................................................................................... 23
The amount of your deduction depends on a few factors .............................................................................23
Watch out--your long-term care insurance benefits may be taxable ............................................................ 24
Sheltering Earned Income from Taxes .................................................................................................................. 25
What is sheltering earned income from taxes? .............................................................................................25
How can a traditional IRA help you to shelter earned income? .................................................................... 25
How can employer-sponsored retirement plans help you to shelter your earned income? .......................... 25
Tax Benefits of Home Ownership .......................................................................................................................... 26
First-time homebuyer tax credit .................................................................................................................... 26
Temporary additional standard deduction for non-itemizers .........................................................................27
Deducting mortgage interest .........................................................................................................................27
Tax treatment of real estate taxes ................................................................................................................ 27
Tax treatment of home improvements and repairs ....................................................................................... 27
Deducting points and closing costs .............................................................................................................. 28
Exclusion of capital gain when your house is sold ........................................................................................28
Tax Shelters ...........................................................................................................................................................30
What is a tax shelter? ................................................................................................................................... 30
Registration and reporting requirements ...................................................................................................... 30
Penalty provisions .........................................................................................................................................31
Potential problems for corporations .............................................................................................................. 32
Should you invest in a tax shelter? ............................................................................................................... 32
February 03, 2011

Tax Planning for Income
What is tax planning for income?

Tax planning for income usually involves strategies for minimizing your taxable income. In particular, the timing and
the method by which your income is reported become paramount. Effective planning begins with an understanding
of the various types of income. Next, you'll want to consider tools for creating tax-free income, methods of sheltering
earned income from taxes, strategies to defer taxes (and other tax-advantaged strategies), and vehicles for shifting
income and tax. For older taxpayers, it's also useful to know how to minimize taxation of your Social Security
benefits.
Why is it important for you to understand the concept of income?

As a general rule, you are required to pay tax on your income from whatever source derived, unless a statutory
exception applies. Therefore, it's important for you to know which items are included and excluded from the IRS's
definition of gross income. Additionally, income can be taxed at different rates, depending on whether the income is
ordinary or derived from the sale or exchange of certain classes of property held for certain minimum time periods.
Because losses can sometimes be used to offset income, it's also important to understand the concept of active
versus passive income.
Why is it important to know how to generate tax-free income?

Although income is usually taxable, there are a number of vehicles that can produce tax-free or nontaxable income.
You may be able to enjoy some portion of your income, tax free, by switching some of your investment money to
these vehicles. Several useful vehicles exist, including Roth IRAs, tax-exempt bonds, and qualified small business
stock.
How can you shelter earned income from taxes?

Sheltering your earned income involves employing one or more tools to generate losses, deductions or credits that
will reduce the current federal tax burden on your earned income. Typically, your desired result is income deferral.
Several methods exist to shelter earned income from taxes, including traditional deductible IRAs and
employer-sponsored retirement plans.
Why should you be aware of strategies to defer taxes?

There are several reasons why deferring the taxation of income is generally desirable. First, deferring taxes will
provide you with more money right now to fund various financial plans. Moreover, certain qualified retirement plans
allow you not only to defer some of your current taxable income, but also let your retirement savings grow tax-free
until a distribution is taken.
As a general rule, when tax rates are stable, it's wise for you to defer the recognition of as much income as possible
to a later year and accelerate deductions. This will allow you to minimize your current income tax liability. As a
consequence, you will be able to invest money that would otherwise have been used to pay income taxes, keeping
that money working for you. When you eventually recognize the income, it's possible that you'll be in a lower tax
bracket.
What are some other tax-advantaged strategies?

Many other tax-advantaged strategies exist. For instance, you should be aware of tax shelters and tools for creating
passive income in order to take advantage of passive losses. Additional strategies that may help you reduce your
overall income tax burden include taking advantage of the tax benefits of generating capital gains, investing in real
estate, receiving annuitized payments, and engaging in year-end tax planning.
February 03, 2011

How can you shift income and tax to others?
Income shifting refers to dividing income among two or more taxpayers in a way that lowers overall taxes. Typically,
income is shifted from higher bracket taxpayers to lower ones. If you're interested in income shifting, you should be
aware of a number of topics, including the kiddie tax, the tax treatment of below-market and interest-free loans, and
the benefits of making gifts of income producing property and employing family members.
What about Social Security benefits?

If you're an older taxpayer, you should probably be concerned with minimizing the taxation of your Social Security
retirement benefits. Certain techniques exist to limit the taxation of such benefits, including filing your income tax
return jointly and employing tools to reduce your modified adjusted gross income.
February 03, 2011

Generating Tax-Free Income
What is generating tax-free income?

To engage in personal income tax planning, you should be aware of a number of concepts, including that of
generating tax-free income. Although income is usually taxable, there are a number of vehicles that can produce
tax-free or nontaxable income. Some of the more popular forms of nontaxable income include the following:
• Roth IRA distributions
• Coverdell education savings account (formerly known as an education IRA) and 529 plan distributions
• Tax-exempt bond interest
• Interest on Series EE savings bonds used for education
• Life insurance (death benefit)
• Loans against and certain withdrawals from cash value insurance
• Certain gains from the sale of qualified small-business stock
• In certain situations, gain on sale of personal residence
How can IRAs be used to generate tax-free income?

Unlike contributions to a traditional individual retirement account (IRA), contributions to a Roth IRA are never tax
deductible. Since you are taxed on your IRA contributions currently, that money will be returned to you tax free when
withdrawn in the future. In addition, the earnings (interest) on Roth IRAs grow federal income tax deferred and are
tax free when withdrawn (assuming your distribution is a "qualified" one). Because of these features, the Roth IRA is
a useful tool for generating tax-free income.
Tip: Employers can allow employees to designate their contributions to a 401(k) or 403(b) plan as
after-tax Roth contributions. Under certain conditions, these contribution amounts and related earnings
will be tax free when distributed.
529 plans and Coverdell education savings accounts

529 plans (which include both 529 college savings plans and 529 prepaid tuition plans) allow individuals to save for
college on a tax-advantaged basis. Any earnings on funds contributed to a 529 plan grow federal income tax
deferred. Withdrawals are not subject to federal income tax if they are used to pay qualified higher education
expenses. If used appropriately to save and pay for college expenses, then, a 529 plan can generate tax-free
income.
The Coverdell ESA is another vehicle that allows individuals to save for a child's higher education on a tax-favored
basis. Like a Roth IRA, your contributions to a Coverdell ESA are not tax deductible. However, the earnings
(interest) in the Coverdell ESA grow federal income tax deferred. Any money you withdraw from the Coverdell ESA
will be tax free if used for qualified education expenses (including elementary and secondary school expenses). A
Coverdell ESA, therefore, will generate tax-free income (if used properly).
How can bonds be used to generate tax-free income?

Tax-exempt bonds and Series EE savings bonds used for education are the two types of bonds that can be used to
generate tax-free income.
February 03, 2011

Tax-exempt bonds
Interest on certain obligations of a state, territory, U.S. possession, or political subdivision can be excluded from
your federal gross income. In addition, if you earn interest on tax-exempt bonds issued in your home state,
generally, the interest will not be subject to state or local tax. Municipal bonds, therefore, can help generate tax-free
income for you.
Caution: For investors who are subject to the alternative minimum tax (AMT), however, interest
income from certain municipal securities must be included in income when calculating the tax.
Series EE savings bonds
The interest received on Series EE savings bonds is exempt from state and local income taxes. In addition, the
interest on Series EE bonds purchased on or after January 1, 1990, may be exempt from federal income taxation if
the bonds are used for certain educational purposes and if certain requirements (including adjusted gross income
limitations) are met. Therefore, assuming you meet the requisite conditions, Series EE savings bonds can generate
tax-free income.
How can life insurance be used to generate tax-free income?

Permanent life insurance can be used to generate tax-free income in two ways. The purchase of insurance should
be considered because of its death benefit proceeds and its cash value buildup.
Death benefit
Generally, amounts you receive under a life insurance contract paid by reason of the death of the insured are not
included in your gross income; the proceeds are tax free. Amounts payable on the death of the insured are
excluded, whether these amounts represent the return of premiums paid, the increased value of the policy due to
investments, or the death benefit feature. It is immaterial whether the life insurance proceeds are received in a
single sum or otherwise. (However, any interest paid along with the life insurance proceeds is usually taxable.)
Cash value insurance transactions
The cash value in a universal life insurance policy can also be a useful tool for generating tax-free income. In
general, amounts received under a life insurance contract (other than an annuity) are treated first as a recovery of
basis; only after the entire basis has been recovered is there taxable income. Therefore, any withdrawal you make
from your cash value life insurance policy (up to the amount of your basis or investment in the contract) can be
taken tax free.
It is also possible for you to obtain a loan from your insurance company in an amount up to the cash value of the
policy. For the most part, loans are not treated as taxable distributions (although interest will be charged by the
insurer). At present, it is possible (in some cases) for an insured to stop paying premiums and use his or her policy's
cash value as a retirement fund of sorts, without paying tax on the cash value. Basically, you borrow the cash value
(even if it exceeds the investment in the policy) and do not have to pay it back until you die or unless the policy
lapses. The loan plus interest will be deducted from the death benefit paid.
Example(s): Assume John buys a $160,000 life insurance policy for which he has paid $40,000 in
premiums to date (basis). The cash surrender value of the policy is $55,000. John borrows $50,000 of
the cash value of the policy to fund his retirement, pays no more premiums, and retains the insurance
coverage as long as the remaining cash value covers future premium payments. As it turns out, the
interest rate that the insurance company charges him for the loan is precisely the same interest rate he
is earning on the cash value, so there is a wash (i.e., the borrowing creates no out-of-pocket cost to
him).
Congress could close the above loophole at some point. Accordingly, a less risky move may be appropriate.
Caution: The above rules do not apply to modified endowment contracts (MECs).
Caution: An outstanding loan is generally treated as an amount received if a policy is surrendered or
February 03, 2011

sold and may result in taxable income.
How can qualified small-business stock be used to generate tax-free

income?
Qualified small-business stock is stock that meets requirements set forth in Internal Revenue Code Section 1202.
Essentially, this is stock issued by domestic C corporations engaged in certain "active businesses" whose assets do
not exceed $50 million. The stock must be issued after August 10, 1993, and must be acquired when originally
issued by the corporation. Noncorporate taxpayers may exclude 50 percent of any capital gain from the sale or
exchange of qualified small-business stock issued after August 10, 1993, and held for more than five years. The
amount of gain eligible for the 50 percent exclusion in a tax year is limited to the greater of:
• Ten times the taxpayer's (aggregate) adjusted basis in the stock that is sold, or
• $10 million of gain from stock in that corporation
For tax years 2005 and thereafter, you can generally exclude up to 60 percent of your gain if you meet the following
additional requirements:
• You sell or trade stock in a corporation that qualifies as an empowerment zone business during
substantially all of the time you held the stock
• You acquired the stock after December 21, 2000
For qualified small business stock issued after February 17, 2009, and before January 1, 2011, the amount that may
be excluded upon sale or exchange of the shares is 70 percent.
Caution: The part of the gain that is included in income will be taxed at a rate of 28 percent.
Caution: Gain from the sale of qualified small-business stock that is excluded from taxable income
may still be subject to the alternative minimum tax.
How can the gain on sale of your personal residence generate tax-free
income?
If you sell your principal residence at a gain, you may be able to exclude from taxation all or part of the capital gain.
If you meet the requirements, you can exclude up to $250,000 (up to $500,000 for married couples filing jointly) of
the gain, regardless of your age.
You can generally exclude the gain only if you owned and used the home as your principal residence for at least two
out of the five years preceding the sale (the two years do not have to be consecutive). An individual, or either
spouse in a married couple, can generally use this exemption only once every two years.
Even if you fail to meet these two tests, though, you may be eligible to claim a partial exemption.
February 03, 2011

Other Tax-Advantaged Strategies
What are some other tax-advantaged strategies?

When engaging in income tax planning, you may be able to reduce your overall tax burden by employing specific
strategies to generate tax-free income, shelter earned income from taxes, and defer taxes. However, other
tax-advantaged strategies exist as well. You might wish to create passive income to take advantage of passive
losses, and you might wish to engage in year-end tax planning. Additionally, it may be wise to consider the tax
benefits of generating capital gains, investing in real estate, and receiving annuitized payments.
Why should you create passive income to take advantage of passive losses?
A passive activity involves the conduct of any trade or business in which you do not materially participate. For
example, if you have an interest in a limited partnership and the partnership generates income, it is likely that your
share of partnership income will be classified as passive. In addition, real estate rental activities are generally
considered passive activities.
Caution: There are special rules if you actively participate in a passive real estate rental activity.
Generally, a loss from a passive activity cannot simply be deducted outright on your personal income tax return;
rather, a passive loss can only be used to offset passive income. Accordingly, if you have passive activity losses,
you can take advantage of the offset provisions by creating passive income. In effect, you will have created tax-free
income, because your passive income will be offset by otherwise unusable passive losses. Generally, unused
passive losses can be carried over to offset passive income in subsequent years, and unused passive activity loss
carryforwards are allowed to be used in full when you dispose of your entire interest in the activity generating the
passive losses in a fully taxable transaction.
Why should you engage in year-end tax planning?

Year-end tax planning may often result in substantial tax savings. Tax planning primarily concerns controlling the
timing and the method by which your income is reported and your deductions and credits claimed. The basic
strategy for year-end tax planning is to time your income so that it will be taxed at a lower rate and time your
deductible expenses so that they may be claimed in years when you are in a higher tax bracket. In a nutshell, you
should try to:
• Recognize income when your tax bracket is low
• Pay deductible expenses when your tax bracket is high
• Postpone tax whenever possible
By using these methods, you can lower your overall tax liability.
Why is it useful to generate capital gains?

If you can generate net capital gains (instead of ordinary income), you may save considerably on your taxes. This is
because the top capital gains rate is substantially lower than the marginal rate applicable to ordinary income. You
generate capital gains by selling capital assets. Another advantage to investing in capital assets involves the timing
of income. You usually have the flexibility to control when you recognize the income or loss because, in most cases,
you determine when to sell your assets.
How is investing in real estate beneficial, from a tax standpoint?

One big advantage of investing in real estate is that any appreciation in value is a tax-deferred gain that will not be
February 03, 2011

recognized until the real estate is sold at a future point. Moreover, if the real estate you invest in is used as your
personal residence, it may be possible for you to exclude all or a portion of the capital gain income when you sell the
residence (if certain conditions are met).
If, on the other hand, you purchase real estate for investment purposes only, you may be able to take advantage of
depreciation and other deductions.
What is the tax advantage to receiving annuitized payments?

When you receive income in the form of periodic annuity payments, you'll pay a smaller amount of taxes in a given
year than you would if you received the money all at once; receiving a lump sum could push you into a higher tax
bracket. With an annuity, on the other hand, part of each annuity payment is taxable, and part is nontaxable.
Moreover, it's possible for the taxable amount to be so small that it will have no impact on your tax bracket.
Basically, each annuity payment you receive represents a return of principal (or your nontaxable investment basis),
plus a taxable interest portion. If you want to figure out which payments are taxable, multiply each payment received
by an "exclusion ratio." The exclusion ratio is determined by dividing your nontaxable investment in the contract by
the contract's expected return (value).
If you purchase a deferred annuity, the annuity can earn interest tax-deferred on an annual basis. The interest is not
taxable in the current year as long as no withdrawals are made. Since you're likely to be in a lower tax bracket by
the time the annuity is paid out (during retirement, perhaps), the income tax effect should be minimal.
February 03, 2011

Tax Planning Tips: Life Insurance
Understanding the importance of life insurance is one thing. Understanding the tax rules is quite another. As
insurance products have evolved and become more sophisticated, the line separating insurance vehicles from
investment vehicles has grown blurry. To differentiate between the two, a mix of complex rules and exceptions now
governs the taxation of insurance products. If you have neither the time nor the inclination to decipher the IRS
regulations, here are some life insurance tax tips and background information to help you make sense of it all.
Life insurance contracts must meet IRS requirements

For federal income tax purposes, an insurance contract cannot be considered a life insurance contract--and qualify
for favorable tax treatment--unless it meets state law requirements and satisfies the IRS's statutory definitions of
what is or is not a life insurance policy. The IRS considers the type of policy, date of issue, amount of the death
benefit, and premiums paid. The IRS definitions are essentially tests to ensure that an insurance policy isn't really an
investment vehicle. The insurance company must comply with these rules and enforce the provisions.
Keep in mind that you can't deduct your premiums on your federal income
tax return
Because life insurance is considered a personal expense, you can't deduct the premiums you pay for life insurance
coverage.
Employer-paid life insurance may have a tax cost

The premium cost for the first $50,000 of life insurance coverage provided under an employer-provided group term
life insurance plan does not have to be reported as income and is not taxed to you. However, amounts in excess of
$50,000 paid for by your employer will trigger a taxable income for the "economic value" of the coverage provided to
you.
You should determine whether your premiums were paid with pre- or
after-tax dollars
The taxation of life insurance proceeds depends on several factors, including whether you paid your insurance
premiums with pre- or after-tax dollars. If you buy a life insurance policy on your own or through your employer, your
premiums are probably paid with after-tax dollars.
Different rules may apply if your company offers the option to purchase life insurance through a qualified retirement
plan and you make pretax contributions. Although pretax contributions offer certain income tax advantages, one
tradeoff is that you'll be required to pay a small tax on the economic value of the "pure life insurance" in the policy
(i.e., the difference between the cash value and the death benefit) each year. Also, at death, the amount of the
policy cash value that is paid as part of the death benefit is taxable income. These days, however, not many
companies offer their employees the option to purchase life insurance through their qualified retirement plan.
Your life insurance beneficiary probably won't have to pay income tax on
death benefit received
Whoever receives the death benefit from your insurance policy usually does not have to pay federal or state income
tax on those proceeds. So, if you die owning a life insurance policy with a $500,000 death benefit, your beneficiary
under the policy will generally not have to pay income tax on the receipt of the $500,000. This is generally true
regardless of whether you paid all of the premiums yourself, or whether your employer subsidized part or all of the
premiums under a group term insurance plan.
Different income tax rules may apply if the death benefit is paid in installments instead of as a lump sum. The
February 03, 2011

interest portion (if any) of each installment is generally treated as taxable to the beneficiary at ordinary income rates,
while the principal portion is tax free.
In some cases, insurance proceeds may be included in your taxable estate

If you hold any incidents of ownership in an insurance policy at the time of your death, the proceeds from that
insurance policy will be included in your taxable estate. Incidents of ownership include the right to change the
beneficiary, the right to take out policy loans, and the right to surrender the policy for cash. Furthermore, if you gift
away an insurance policy within three years of your death, then the proceeds from that policy will be pulled back into
your taxable estate. To avoid having the policy included in your taxable estate, someone other than you (e.g., a
beneficiary or a trust) should be the owner.
Note: If the owner, the insured, and the beneficiary are three different people, the payment of death benefit proceeds
from a life insurance policy to the beneficiary may result in an unintended taxable gift from the owner to the
beneficiary.
If your policy has a cash value component, that part will accumulate tax
deferred
Unlike term life insurance policies, some life insurance policies (e.g., permanent life) have a cash value component.
As the cash value grows, you may ultimately have more money in cash value than you paid in premiums. Generally,
you are allowed to defer income taxes on those gains as long as you don't sell, withdraw from, or surrender the
policy. If you do sell, surrender, or withdraw from the policy, the difference between what you get back and what you
paid in is taxed as ordinary income.
You usually aren't taxed on dividends paid

Some policies, known as participating policies, pay dividends. An insurance dividend is the amount of your premium
that is paid back to you if your insurance company achieves lower mortality and expense costs than it expected.
Dividends are paid out of the insurer's surplus earnings for the year. Regardless of whether you take them in cash,
keep them on deposit with the insurer, or buy additional life insurance within the policy, they are considered a return
of premiums. As long as you don't get back more than you paid in, you are merely recouping your costs, and no tax
is due. However, if you leave these dividends on deposit with your insurance company and they earn interest, the
interest you receive should be included as taxable interest income.
Watch out for cash withdrawals in excess of basis--they're taxable

If you withdraw cash from a cash value life insurance policy, the amount of withdrawals up to your basis in the policy
will be tax free. Generally, your basis is the amount of premiums you have paid into the policy less any dividends or
withdrawals you have previously taken. Any withdrawals in excess of your basis (gain) will be taxed as ordinary
income. However, if the policy is classified as a modified endowment contract (MEC) (a situation that occurs when
you put in more premiums than the threshold allows), then the gain must be withdrawn first and taxed.
Keep in mind that if you withdraw part of your cash value, the death benefit available to your survivors will be
reduced.
You probably won't have to pay taxes on loans taken against your policy
If you take out a loan against the cash value of your insurance policy, the amount of the loan is not taxable (except
in the case of an MEC). This result is the case even if the loan is larger than the amount of the premiums you have
paid in. Such a loan is not taxed as long as the policy is in force.
If you take out a loan against your policy, the death benefit and cash value of the policy will be reduced.
February 03, 2011

You can't deduct interest you've paid on policy loans
The interest you pay on any loans taken out against the cash value of your life insurance is not tax deductible.
Certain loans on business-owned policies are an exception to this rule.
The surrender of your policy may result in taxable gain

If you surrender your cash value life insurance policy, any gain on the policy will be subject to federal (and possibly
state) income tax. The gain on the surrender of a cash value policy is the difference between the gross cash value
paid out (plus any loans outstanding) and your basis in the policy. Your basis is the total premiums that you paid in
cash, minus any policy dividends and tax-free withdrawals that you made.
You may be able to exchange one policy for another without triggering tax
liability
The tax code allows you to exchange one life insurance policy for another (or a life insurance policy for an annuity)
without triggering current tax liability. This is known as a Section 1035 exchange. However, you must follow the
IRS's rules when making the exchange.
When in doubt, consult a professional

The tax rules surrounding life insurance are obviously complex and are subject to change. For more information,
contact a qualified insurance professional, attorney, or accountant.
February 03, 2011

Tax Planning Tips: Disability Insurance
The income you receive from disability income insurance may or may not be taxable. The taxability of disability
income insurance benefits depends on what type of benefits you receive, whether the premiums were paid with
pretax or after-tax dollars, and who paid the premiums (you or your employer).
Individual disability income insurance

The rules surrounding taxation of individual disability income insurance benefits are generally simple. Because you
pay the premiums with after-tax dollars, the benefits you receive are tax free. However, unlike health insurance
premiums, you can't deduct premiums paid for individual disability income insurance as a medical expense.
Sometimes, your employer pays for an individual disability insurance policy on you. This may be the case if you are
considered to be a key employee of the business. If so, different rules may apply. If the employer gets the benefit,
then the premium is not deductible to the company, and the benefit is not taxable when received by the company.
Employer-sponsored group disability insurance

If you are enrolled in a group disability insurance plan sponsored by your employer, the taxability of your benefits
depends on who pays the premium. If you pay the total premium using after-tax income, then your benefits will be
tax free. On the other hand, if your employer pays the total premium and does not include the cost of coverage in
your gross income, then your benefits will be taxable.
If your employer pays part of the insurance premium and you pay the rest, then your tax liability will be split as well.
The part of the benefit you receive that is related to the employer-paid share of the premium is taxable; any part of
the benefit related to your share of the premium is tax free.
If you pay part of the premium for employer-sponsored disability coverage, the type of dollars you use to pay the
premium determines whether your benefit will be taxable. If you pay your part of the premium with pretax dollars,
through a cafeteria or medical reimbursement plan, you'll owe income tax on any disability benefit you receive that is
related to that part of the premium. On the other hand, if you pay your part of the premium with after-tax dollars, you
won't owe income tax on any disability benefit you receive that is related to that part of the premium.
Benefits under a cafeteria plan

An employer-sponsored cafeteria plan allows you to select among certain employee benefits, including health, life,
and disability insurance. You normally pay for these benefits on a pretax basis. Sometimes, however, your employer
pays the premium for the benefits you choose (up to a certain amount), and if you choose additional benefits, you
pay for extra coverage using either pretax or after-tax dollars.
If you pay your share of the premium with after-tax dollars, that portion of your disability benefits will be considered
tax-free income; you'll be taxed only on the portion of the benefit related to your employer's contribution. However, if
you pay your share with pretax dollars, that portion of your disability benefits will be considered taxable income, and
you'll have to pay income tax on all of your benefit.
If you are totally and permanently disabled, and you receive fully or partially taxable disability benefits from an
employer-sponsored disability insurance plan, you may be eligible to claim a tax credit when you file your annual
income tax return.
Group association disability insurance

Disability policies purchased through an association are called group policies because members of the association
are offered special terms, conditions, and rates based on the characteristics of that group. Association policies
function much like individual policies and have similar tax consequences. If you pay the premiums for an association
policy, the benefits you receive are tax free, but you cannot deduct the cost of the premiums.
February 03, 2011

Government disability insurance
All, part, or none of the disability benefits you receive through government disability insurance programs may be
taxable. How much of the benefit is taxable (and under what circumstances) depends on the type of government
disability benefit you are receiving:
Social Security benefits: If the only income you had during the year was Social Security disability income, your
benefit usually isn't taxable. However, if your total income exceeds a certain base amount and you earned other
income during the year (or had substantial investment income), then you might have to pay tax on part of your
benefit. More specifically, your Social Security benefit is taxable if your modified adjusted gross income plus one-half
of your Social Security benefit exceeds the base amount for your filing status.
Medicare benefits: When you are disabled, you may be eligible to enroll in Medicare. If you pay premiums for the
medical insurance portion of Medicare, you may deduct these premiums as a medical expense (provided, of course,
that your medical expenses exceed 7.5 percent of your adjusted gross income). In addition, Medicare benefits you
receive are not taxable.
Note: Starting in 2013, the threshold to deduct medical expenses will be raised from 7.5 percent of adjusted gross
income to 10 percent. The threshold increase will be delayed until 2017 for those age 65 or older.
Workers' compensation: Generally, if you receive a disability benefit from workers' compensation, that benefit won't
be taxable. Any benefits paid to your survivors would also be tax exempt. However, in certain cases, you may be
able to return to work and continue to receive payments. If this is the case, then your workers' compensation benefit
would be taxable. Note, though, that if part of your workers' compensation benefit offsets (reduces) your Social
Security benefit, then that part is considered to be a Social Security benefit. It may then be taxable according to the
rules governing Social Security.
Veterans benefits: Disability benefits you receive from the Department of Veterans Affairs, formerly known as the
Veterans Administration, are not taxable, except for certain payments for rehabilitative services.
Military benefits: Most military disability pensions are taxable. However, if you were disabled due to injury or illness
resulting from active service in the armed forces of any country, your disability benefits may be tax free under certain
conditions.
Federal employees retirement system (FERS) benefits: If you retire on disability, the payments under FERS that you
receive from a pension or annuity are taxable as wages until you reach minimum retirement age. Beginning on the
day after you reach minimum retirement age, payments you receive are taxable as a pension.
Is it wiser to buy disability coverage with pretax or after-tax dollars?

If you pay for disability income insurance with pretax dollars, you are (in effect) reducing your taxable income. This
means that you won't have income taxes withheld on the portion of your income you used to pay your disability
income insurance premium. However, you also have to consider how your benefit would be taxed if you ever begin
receiving disability benefits. If you use pretax dollars to pay your insurance premium, then your benefit would be fully
taxable. However, if you use after-tax dollars, your benefit won't be taxable.
It comes down to this: If you never use your disability benefits, you'll save money by paying your premiums with
pretax dollars. But if you do use your disability benefits, using after-tax dollars to pay your premiums places you in a
better position. Consult your tax professional for advice.
February 03, 2011

Tax Planning for Annuities
Favorable tax treatment is one of the main reasons for buying an annuity. But what exactly are the tax benefits? And
are there any drawbacks? It's important to know the answers to these questions before deciding whether to
purchase an annuity.
Of course, any information pertaining to taxes is complex, full of exceptions, and subject to change. This discussion
deals with the general rules for taxation of annuities--you should consult a tax advisor for more specific information
before you take any action.
Taxation of premiums
Annuities are typically funded with after-tax dollars. So, the money you pay into an annuity (in the form of premiums)
is nondeductible. By placing funds in an annuity, you will not realize any current income tax savings, unlike putting
money into a traditional IRA, 401(k) plan, or other employer-sponsored retirement plan.
Tax-deferred growth
Unlike most investments, an increase in the value of an annuity from interest is not currently taxable. Generally,
annuity funds are allowed to grow tax deferred until they're distributed, at which time the owner will pay ordinary
income tax on all gains.
Taxation of premature withdrawals

Withdrawals taken before age 59½ may be subject to a 10 percent IRS penalty tax unless an exception applies.
When you make a withdrawal from an annuity, the IRS assumes that earnings are withdrawn first. The 10 percent
penalty applies to the earnings portion of a withdrawal. So, early withdrawals are costly from a tax standpoint.
For example, if your annuity has grown by $1,000 since you purchased it, a $500 withdrawal would be considered
100 percent interest and would be subject to the 10 percent penalty--in this case, $50. In addition, because the
entire withdrawal represents earnings, it would be subject to ordinary income tax. If you are in the 25 percent tax
bracket, your income tax liability on the withdrawal would be $125. Adding this to the early withdrawal penalty, $175
of your $500 withdrawal would end up in the IRS's pocket.
Taxation of scheduled distributions

If you choose an annuitization option, you will begin receiving regular distributions from your annuity over a
predetermined period of time. Each distribution consists of two components: principal (a return of the money you
paid into the annuity) and earnings. The percentages of principal and earnings of each distribution will depend on
the annuitization option chosen. Again, the earnings portion of each distribution will be treated as ordinary income.
Also, depending on the annuitization option chosen, the 10 percent penalty rule may not apply.
Note: Annuity guarantees are subject to the claims-paying ability of the annuity issuer.
Taxation of lump-sum distributions

Taking a lump-sum distribution of your annuity funds can have many consequences. If you make this election within
the first few years after purchasing your annuity, you may be subject to surrender charges imposed by the issuer. In
any case, the earnings portion of the distribution will be treated as ordinary income in the year you take the
distribution. Also, keep in mind that a large lump-sum distribution could actually push you into a higher tax bracket,
dramatically increasing your tax liability.
February 03, 2011

Tax Planning for the Self-Employed
Self-employment is the opportunity to be your own boss, to come and go as you please, and oh yes, to establish a
lifelong bond with your accountant. If you're self-employed, you'll need to pay your own FICA taxes and take charge
of your own retirement plan, among other things. Here are some planning tips.
Understand self-employment tax and how it's calculated

As a starting point, make sure that you understand (and comply with) your federal tax responsibilities. The federal
government uses self-employment tax to fund Social Security and Medicare benefits. You must pay this tax if you
have more than a minimal amount of self-employment income. If you file a Schedule C as a sole proprietor,
independent contractor, or statutory employee, the net profit listed on your Schedule C (or Schedule C-EZ) is
self-employment income and must be included on Schedule SE, which is filed with your federal Form 1040.
Schedule SE is used both to calculate self-employment tax and to report the amount of tax owed. For more
information, see IRS Publication 533.
Make your estimated tax payments on time to avoid penalties

Employees generally have income tax, Social Security tax, and Medicare tax withheld from their paychecks. But if
you're self-employed, it's likely that no one is withholding federal and state taxes from your income. As a result, you'll
need to make quarterly estimated tax payments on your own (using IRS Form 1040-ES) to cover your federal
income tax and self-employment tax liability. You may have to make state estimated tax payments, as well. If you
don't make estimated tax payments, you may be subject to penalties, interest, and a big tax bill at the end of the
year. For more information about estimated tax, see IRS Publication 505.
If you have employees, you'll have additional periodic tax responsibilities. You'll have to pay federal employment
taxes and report certain information. Stay on top of your responsibilities and see IRS Publication 15 for details.
Employ family members to save taxes

Hiring a family member to work for your business can create tax savings for you; in effect, you shift business income
to your relative. Your business can take a deduction for reasonable compensation paid to an employee, which in
turn reduces the amount of taxable business income that flows through to you. Be aware, though, that the IRS can
question compensation paid to a family member if the amount doesn't seem reasonable, considering the services
actually performed. Also, when hiring a family member who's a minor, be sure that your business complies with child
labor laws.
As a business owner, you're responsible for paying FICA (Social Security and Medicare) taxes on wages paid to
your employees. The payment of these taxes will be a deductible business expense for tax purposes. However, if
your business is a sole proprietorship and you hire your child who is under age 18, the wages that you pay your
child won't be subject to FICA taxes.
As is the case with wages paid to all employees, wages paid to family members are subject to withholding of federal
income and employment taxes, as well as certain taxes in some states.
Establish an employer-sponsored retirement plan for tax (and nontax)

reasons
Because you're self-employed, you'll need to take care of your own retirement needs. You can do this by
establishing an employer-sponsored retirement plan, which can provide you with a number of tax and nontax
benefits. With such a plan, your business may be allowed an immediate federal income tax deduction for funding the
plan. You can also generally place pretax dollars into a retirement account to grow tax deferred until withdrawal. You
may want to use one of the following types of retirement plans:
February 03, 2011

• Keogh plan
• Simplified employee pension (SEP)
• SIMPLE IRA
• SIMPLE 401(k)
• Individual (or "solo") 401(k)
The type of retirement plan that your business should establish depends on your specific circumstances. Explore all
of your options and consider the complexity of each plan. And bear in mind that if your business has employees, you
may have to provide coverage for them as well. For more information about your retirement plan options, consult a
tax professional or see IRS Publication 560.
Take full advantage of all business deductions to lower taxable income

Because deductions lower your taxable income, you should make sure that your business is taking advantage of
any business deductions to which it is entitled. You may be able to deduct a variety of business expenses, including
rent or home office expenses, and the costs of office equipment, furniture, supplies, and utilities. To be deductible,
business expenses must be both ordinary (common and accepted in your trade or business) and necessary
(appropriate and helpful for your trade or business). If your expenses are incurred partly for business purposes and
partly for personal purposes, you can deduct only the business-related portion.
If you're concerned about lowering your taxable income this year, consider the following possibilities:
• Deduct the business expenses associated with your motor vehicle, using either the standard mileage
allowance or your actual business-related vehicle expenses to calculate your deduction
• Buy supplies for your business late this year that you would normally order early next year
• Purchase depreciable business equipment, furnishings, and vehicles this year
• Deduct the appropriate portion of business meals, travel, and entertainment expenses
• Write off any bad business debts
Self-employed taxpayers who use the cash method of accounting have the most flexibility to maneuver at year-end.
See a tax specialist for more information.
Deduct health-care related expenses

If you qualify, you may be able to benefit from the self-employed health insurance deduction, which would enable
you to deduct up to 100 percent of the cost of health insurance that you provide for yourself, your spouse, and your
dependents. This deduction is taken on the front of your federal Form 1040 (i.e., "above-the-line") when computing
your adjusted gross income, so it's available whether you itemize or not.
Contributions you make to a health savings account (HSA) are also deductible "above-the-line." An HSA is a
tax-exempt trust or custodial account you can establish in conjunction with a high-deductible health plan to set aside
tax-free funds for health-care expenses.
Note: Starting in 2010, small businesses with fewer than 25 employees that pay at least 50 percent of the
health-care premiums for their employees qualify for a tax credit up to 35 percent of premiums (50 percent after
2014 insurance is purchased through an exchange). However, this tax deduction is not available to self-employed
individuals (or sole proprietors).
February 03, 2011

And starting in 2014
Starting in 2014, many self-employed individuals will qualify for a federal subsidy to help them afford the cost of
purchasing health care. Those earning up to 400 percent of the poverty level will get assistance, or up to $88,200 for
a family of four (at today's poverty level).
Also, Small Business Health Options Programs (SHOP) exchanges will be established. These exchanges will
enable self-employed individuals (as well as companies with up to 100 employees) to pool together to have greater
buying power. This should result in lower premium costs.
Additionally, more lower-income individuals and childless adults will be covered by Medicaid, the federal health
insurance plan for the poor. This may be a big help, especially for self-employed individuals and those just starting a
business, who may not have much income.
February 03, 2011

Tax Tips: Health Insurance
Your health insurance coverage probably came in handy several times over the past year. It all seemed so simple at
the time--you paid a deductible, and your insurance usually kicked in the rest. But what do you do at tax time? Just
what are you taxed on, and what can you deduct on your federal income tax return?
Your income taxes may be affected by two aspects of your health insurance plan--the premiums and the benefits.
Here's what you need to know.
You don't include employer-paid premiums in your income

For tax purposes, you can generally exclude from your income any health insurance premiums (including Medicare)
paid by your employer. The premiums can be for insurance covering you, your spouse, and any dependents. It
doesn't matter whether the premiums paid for an employer-sponsored group policy or an individual policy. You can
even exclude premiums that your employer pays when you are laid off from your job.
What if your employer reimburses you for your premiums?

If you pay the premiums on your health insurance policy and receive a reimbursement from your employer for those
premiums, the amount of the reimbursement is not taxable income. However, if your employer simply pays you a
lump sum that may be used to pay health insurance premiums but is not required to be used for this purpose, that
amount is taxable.
In most cases, you won't be able to deduct the premiums you pay
The deductibility of health insurance premiums follows the rules for deducting medical expenses. Usually, the
premiums you pay on an individual health insurance policy won't be deductible. However, if you itemize deductions
on Schedule A, and your unreimbursed medical expenses exceed 7.5 percent of your adjusted gross income (AGI)
in any tax year, you may be able to take a deduction. You can deduct the amount by which your unreimbursed
medical expenses exceed this 7.5 percent threshold.
For example, if your AGI is $100,000, then 7.5 percent of your AGI is $7,500. If your unreimbursed medical
expenses amount to $8,000 and you itemize deductions, you'll be able to deduct $500 worth of your expenses.
Unreimbursed medical expenses include premiums paid for major medical, hospital, surgical, and physician's
expense insurance, and amounts paid out of your pocket for treatment not covered by your health insurance.
Note: Beginning in 2013, the threshold to deduct medical expenses will be raised from 7.5 percent of adjusted gross
If you're self-employed, special deduction rules may apply

In addition to the general rule of deducting premiums as medical expenses, self-employed individuals can deduct a
percentage of their health insurance premiums as business expenses. These deductions aren't limited to amounts
over 7.5 percent of AGI, as are medical expense deductions. They are limited, though, to amounts less than an
individual's earned income. The definition of self-employed individuals includes sole proprietors, partners, and 2
percent S corporation shareholders.
If you qualify, you can deduct 100 percent of the cost of health insurance that you provide for yourself, your spouse,
and your dependents. This deduction is taken on the front of your federal Form 1040; the portion of your health
insurance premiums that is not deductible there can be added to your total medical expenses itemized in Schedule
A.
February 03, 2011

Your health insurance benefits typically aren't taxable
Whether we're talking about an employer-sponsored group plan or a health insurance policy you bought on your
own, you generally aren't taxed on the health insurance benefits you receive.
What about reimbursements for medical care? You can generally exclude from income reimbursements for hospital,
surgical, or medical expenses that you receive from your employer's health insurance plan. These reimbursements
can be for your own expenses or for those of your spouse or dependents. The exclusion applies regardless of
whether your employer provides group or individual insurance, or serves as a self-insurer. The reimbursements can
be for actual medical care or for insurance premiums on your own health insurance.
Note that there is no dollar limit on the amount of tax-free medical reimbursements you can receive in a year.
However, if your total reimbursements for the year exceed your actual expenses, and your employer pays for all or
part of your health insurance premiums, you may have to include some of the excess in your income.
February 03, 2011

Tax Tips: Long-Term Care Insurance
Your chances of requiring some sort of long-term care increase as you age, and long-term care insurance (LTCI)
can help you cover your long-term care expenses. Although tax issues are probably not foremost in your mind when
you buy LTCI, it still pays to consider them. In particular, you should explore whether your premiums will be
deductible and your benefits taxable.
You may be eligible for an income tax deduction

You may be able to deduct all or part of the LTCI premiums you pay for yourself, your spouse, or a dependent, but
only if your policy meets the IRS criteria for a qualified policy. If you bought the policy before January 1, 1997, and it
met the requirements of the state where it was issued, it is automatically considered a qualified policy. If you bought
the policy later, it must satisfy several requirements to be considered qualified.
First of all, the policy must provide coverage only for qualified long-term care services. These include necessary
diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, as well as maintenance or
personal care services that are required by a chronically ill individual, in connection with a plan of care prescribed by
a licensed health-care practitioner. Also, your policy must satisfy the following conditions:
• It must be guaranteed renewable, meaning that you can renew your policy as needed without undergoing
additional medical exams
• It must not have a cash surrender value or any provision that allows you to cash in, pledge, assign, or
borrow against the policy, or receive anything more than a refund of premiums paid if you cancel the
policy
• It must provide that any refunds and dividends (other than refunds upon termination of the policy) can be
used only to reduce future premiums or increase future benefits
• It must not pay for (or reimburse) expenses that are reimbursable under Medicare, unless Medicare is a
secondary payer, or unless the policy pays a specified amount per day regardless of actual expenses
• It must meet certain consumer protection requirements set out in the Internal Revenue Code
The amount of your deduction depends on a few factors

If your LTCI policy meets the conditions listed above, or if it was issued before January 1, 1997, at least part of your
premium may be tax deductible as a medical expense. To qualify for a medical expense deduction, your
unreimbursed medical expenses (including LTCI premiums) must exceed 7.5 percent of your adjusted gross
income. Also, you must itemize your deductions.
Note: Starting in 2013, the threshold to deduct medical expenses will be raised from 7.5 percent of adjusted gross
The maximum amount of LTCI premiums that you can deduct in a year depends on your age at the end of the year.
In 2011, deduction limits (which are indexed each year for inflation) are as follows:
Age Limit on Deduction

40 or younger $340
41 to 50 $640
51 to 60 $1,270
61 to 70 $3,390
February 03, 2011

71 or older $4.240
Watch out--your long-term care insurance benefits may be taxable

A qualified LTCI contract is treated as an accident and health insurance contract, and the benefits are typically
treated as tax free. However, if your contract pays a set dollar amount per day (per diem), the tax-free treatment is
subject to a certain limit, indexed annually for inflation. Benefits over and above this limit are generally considered
taxable income.
Under this limit, the amount of your LTCI benefits that is excluded from taxation in a given period is figured by
subtracting any reimbursement received (through insurance or otherwise) for the cost of qualified long-term care
services during the period from the larger of the following amounts:
• The actual cost of qualified long-term care services during the period
• The dollar amount for the period ($300 per day for any period in 2011)
It's a different story if you have a nonqualified LTCI policy, though. Such benefits may be subject to income tax.
February 03, 2011

Sheltering Earned Income from Taxes
What is sheltering earned income from taxes?

Sheltering your earned income involves employing one or more tools to minimize your current federal tax burden.
Typically, your desired result is income deferral. There are different types of income, but earned income may be
defined as wages, salaries, tips, and other employee compensation, plus net earnings from self-employment.
Although numerous opportunities exist to shelter earned income from taxes, the more widely used methods include
traditional deductible IRAs and employer-sponsored retirement plans. (In some cases, you may also be able to
shelter earned income with ordinary deductions and losses.)
Often, the earnings that accrue on your contributions to retirement plans are tax deferred; that is, you are not
required to include the amount of contributions to such plans in your gross income, but instead must include such
amounts in income when distributed. One of the main advantages of deferring taxation on current income through
retirement plan contributions is that when you eventually collect the benefits, it is possible that you'll be retired
and/or in a lower tax bracket. In addition, prior to any distributions, your investment earnings will compound free of
taxes within the plan.
How can a traditional IRA help you to shelter earned income?

Contributions to a traditional IRA can be tax deductible if you meet the applicable requirements. (A number of rules
apply, but basically, the deductibility of your contributions may be limited, or eliminated, if your modified adjusted
gross income (AGI) exceeds a specified threshold for your filing status when you are an active participant in another
qualified retirement plan.) If an IRA contribution is tax deductible, then you may lower your AGI by the amount of the
contribution. Essentially, you are deferring the taxation of your contribution until you withdraw that money from your
IRA account at some future point. Thus, the traditional (deductible) IRA allows you to shelter your earned income
from current taxation. The earnings that accrue on your contributions also grow tax free until you take an IRA
distribution.
How can employer-sponsored retirement plans help you to shelter your

earned income?
Like IRAs, many employer-sponsored retirement plans provide for the deferral of taxation on plan contributions.
There are two kinds of retirement plans--qualified plans and nonqualified plans. Qualified plans offer significant tax
advantages to employers and their employees in return for strict adherence to ERISA requirements involving
participation in the plan, vesting, funding, disclosure, and fiduciary matters. Nonqualified plans, on the other hand,
generally do not impose such extensive ERISA requirements, but they are generally less beneficial from a tax
standpoint. Of course, there are certain exceptions to this statement.
There are many types of employer-sponsored qualified retirement plans that allow you to contribute pretax
compensation dollars into the plan. These contributions are deducted from your paycheck and are not reflected as
income on your W-2 statement. You include amounts contributed to such qualified retirement plans in your income if
and when you take a distribution from your retirement account in the future. As with IRAs, your money (including the
earnings) grows tax free until it is distributed. This is a significant advantage, especially if you do not intend to take
distributions from the plan for several years.
February 03, 2011

Tax Benefits of Home Ownership
In tax lingo, your principal residence is the place where you legally reside. It's typically the place where you spend
most of your time, but several other factors are also relevant in determining your principal residence. Many of the tax
benefits associated with home ownership apply mainly to your principal residence--different rules apply to second
homes and investment properties. Here's what you need to know to make owning a home really pay off at tax time.
First-time homebuyer tax credit

You may qualify for a federal income tax credit of up to 10 percent of the purchase price of a principal residence
(subject to the dollar limitations described below) if you meet certain requirements:
• The home must have been purchased on or after January 1, 2009 and before May 1, 2010. If you entered
into a written binding contract before May 1, 2010, you can still qualify if you close on the home before
October 1, 2010. (The time period is extended for members of the uniformed services and others who
receive government orders for qualified official extended duty.)
• If you, and your spouse if you're married, haven't owned a principal residence in three years, you may
qualify for a credit of up to $8,000 ($4,000 if you're married and file a separate return).
• For home purchases after November 6, 2009, you may qualify for a credit of up to $6,500 ($3,250 if you're
married and file a separate return) if you, and your spouse if you're married, have maintained the same
principal residence for at least five consecutive years in the eight years preceding the purchase.
• For home purchases after November 6, 2009, you can't claim the credit if the purchase price of the home
exceeds $800,000.
Note: Special rules relating to the first-time homebuyer credit, not discussed here, apply to home purchases made
on or after April 9, 2008, and before January 1, 2009.
Generally, you won't have to pay back the credit (prior to January 1, 2009 the credit had to be paid back over 15
years in equal installments). There's one important exception, however: If the home ceases to be your principal
residence in the 36 months following the purchase, you'll have to pay the credit back. If you're married at the time of
purchase, the home must remain the principal residence of either you or your spouse for the 36-month period.
The credit is reduced or eliminated for individuals with higher modified adjusted gross income ("MAGI"). The income
levels that apply depend on your filing status and when the purchase is made:
Qualifying home purchase:

Filing status: 1/1/09 through 11/6/09 11/7/09 through 4/30/10
Married Filing joint Credit reduced if MAGI exceeds $150,000, Credit reduced if MAGI exceeds $225,000,
eliminated when MAGI reaches $170,000 eliminated when MAGI reaches $245,000
All Others Credit reduced if MAGI exceeds $75,000, Credit reduced if MAGI exceeds $125,000,
eliminated when MAGI reaches $95,000 eliminated when MAGI reaches $145,000
Additional restrictions apply as well. For example, you can't claim the credit if you're a nonresident alien. And, for
purchases after November 6, 2009, you can't claim the credit if you're under age 18 at the time of the purchase
(unless you're married and your spouse is at least 18), or if you can be claimed by someone else as a dependent.
If you purchased a qualifying principal residence in 2009, you could elect to treat the purchase as if it occurred on
December 31, 2008. Similarly, a qualifying purchase in 2010 can be treated as if it occurred on December 31, 2009,
allowing you to claim the credit on your 2009 federal income tax return.
February 03, 2011

Temporary additional standard deduction for non-itemizers
For tax years 2008 and 2009, homeowners were able to claim an additional standard deduction for property tax if
they did not itemize. The additional amount that could be claimed was the lesser of:
• The amount of real estate property taxes paid during the year to state and local governments; or
• $500 ($1,000 if married filing jointly)
Deducting mortgage interest

One of the most important tax advantages of home ownership is the deduction of mortgage interest. If you itemize
deductions on Schedule A of your federal income tax return, you can generally deduct the qualified residence
interest that you pay on certain home mortgages taken on your principal residence. (This also applies to second
homes.) That is, you may be able to deduct the interest you've paid on a mortgage to buy, build, or improve your
home, provided that the loan is secured by your home. Such a mortgage is known as acquisition indebtedness by
the IRS. Your ability to deduct interest depends on several factors.
Up to $1 million of acquisition mortgage debt ($500,000 if you're married and file separately) qualifies for interest
deduction. (Different rules apply if you incurred the debt before October 14, 1987.) If your mortgage loan exceeds $1
million, some of the interest that you pay on the loan will not be deductible.
Although this deduction also applies to certain home equity loans secured by your home, the rules are different.
Home equity debt involves a loan secured by your main or second home that exceeds the outstanding mortgages on
the property. Home equity debt is limited to the lesser of:
• The fair market value of the home minus the total acquisition debt on that home, or
• $100,000 (or $50,000 if your filing status is married filing separately) for main and second homes
combined
The interest that you pay on a qualifying home equity loan is generally deductible regardless of how you use the
loan proceeds. For more information, see IRS Publication 936.
Note: Qualified mortgage insurance payments paid in 2007 through 2010 can be deducted in the same manner as
qualified mortgage interest, but only for mortgage insurance contracts issued on or after January 1, 2007 and before
January 1, 2011. In addition, the deduction is phased out if your adjusted gross income exceeds $100,000 ($50,000
if married filing separate).
Tax treatment of real estate taxes

Along with mortgage interest, you can generally deduct the real estate taxes that you've paid on your property in the
year that they're paid to the taxing authority. Only the legal property owner can deduct the real estate taxes. In some
cases, prepaid real estate taxes can be deducted in the year of the prepayment. Taxes placed in escrow but not yet
paid to the taxing authority, however, generally aren't deductible.
Tax treatment of home improvements and repairs

Home improvements and repairs are generally nondeductible. Improvements, though, can increase the tax basis of
your home (which in turn can lower your tax bite when you sell your home). Improvements add value to your home,
prolong its life, or adapt it to a new use. For example, the installation of a deck, a built-in swimming pool, or a
second bathroom would be considered an improvement. In contrast, a repair simply keeps your home in good
operating condition. Regular repairs and maintenance (e.g., repainting your house and fixing your gutters) are not
considered improvements and are not included in the tax basis of your home. However, if repairs are performed as
part of an extensive remodeling of your home, the entire job may be considered an improvement.
If you make certain improvements to your home that improve your home's energy efficiency, you may be eligible for
February 03, 2011

one or more federal income tax credits.
Deducting points and closing costs

Buying a home is confusing enough without wondering how to handle the settlement charges at tax time. When you
take out a loan to buy a home, or when you refinance an existing loan on your home, you'll probably be charged
closing costs. These usually include points, as well as attorney's fees, recording fees, title search fees, appraisal
fees, and loan or document preparation and processing fees. You'll need to know whether you can deduct these
fees (in part or in full) on your federal income tax return, or whether they're simply added to the cost basis of your
home.
Before we get to that, let's define one term. Points are costs that your lender charges when you take a loan secured
by your home. One point equals 1 percent of the loan amount borrowed. As a home buyer, you can deduct points in
the year that you buy your home if you itemize your deductions. However, you must meet certain requirements. You
can even deduct points that the seller pays for you. More information about these requirements is available in IRS
Publication 936.
Refinanced loans are treated differently. The points that you pay on a refinanced loan generally must be amortized
over the life of the loan. In other words, you can deduct a certain portion of the points each year. There's one
exception: If part of the loan is used to make improvements to your principal residence, you can generally deduct
that portion of the points in the year that the points are paid.
And what about other closing costs? Generally, you cannot deduct these costs on your tax return. Instead, you must
adjust your tax basis (the cost, plus or minus certain factors) in your home. For example, if you're buying a home,
you'd increase your basis with certain closing costs. If you're selling a home, you'd decrease your amount realized
from the sale (i.e., your sale price). For more information, see IRS Publication 530.
Exclusion of capital gain when your house is sold

Now let's see what happens when you sell your home. If you sell your principal residence at a loss, you generally
can't deduct the loss on your tax return. If you sell your principal residence at a gain, however, you may be able to
exclude from taxation all or part of the capital gain.
Generally speaking, capital gain (or loss) on the sale of your principal residence equals the sale price minus your
adjusted basis in the property. Your adjusted basis is the cost of the property (i.e., what you paid for it initially), plus
amounts paid for capital improvements, less any depreciation and casualty losses claimed for tax purposes.
If you meet the requirements, you can exclude from federal income tax up to $250,000 ($500,000 if you're married
and file a joint return) of any capital gain that results from the sale of your principal residence, regardless of your
age. In general, an individual, or either spouse in a married couple, can use this exclusion only once every two
years. To qualify for the exclusion, you must have owned and used the home as your principal residence for a total
of two out of the five years before the sale.
For example, you and your spouse bought your home in 1981 for $200,000. You've lived in it ever since and file joint
federal income tax returns. You sold the house yesterday for $350,000. Your entire $150,000 gain ($350,000 -
$200,000) is excludable. That means that you don't have to report your home sale on your income tax return.
What if you fail to meet the two-out-of-five-years rule? Or what if you used the capital gain exclusion within the past
two years with respect to a different principal residence? You may still be able to exclude part of your gain if your
home sale was due to a change in place of employment, health reasons, or certain other unforeseen circumstances.
In such a case, exclusion of the gain may be prorated.
Additionally, special rules may apply in the following cases:
• If your principal residence contained a home office or was otherwise used partially for business purposes
• If you sell vacant land adjacent to your principal residence
• If your principal residence is owned by a trust
February 03, 2011

• If you rented part of your principal residence to tenants
• If you owned your principal residence jointly with an unmarried taxpayer
Note: Members of the uniformed services, foreign services, and intelligence community, as well as certain Peace
Corps volunteers and employees may elect to suspend the running of the 2-out-of-5-year requirement during any
period of qualified official extended duty up to a maximum of 10 years.
Consult a tax professional for details.
February 03, 2011

Tax Shelters
What is a tax shelter?

In general
A tax shelter is any entity, investment, plan or arrangement created for the purpose of avoiding (or postponing)
federal income tax. Prior to August 6, 1997, the tax shelter regulations were only triggered when the taxpayer's
principal purpose was to avoid taxes. Some tax shelters must be registered under federal and/or state laws
regulating securities.
In the past, real estate partnerships, rolling stock (railroad box cars), and oil and gas partnerships were enormously
popular tax shelters for investors. However, as a result of the Tax Reform Act of 1986 there are only a few tax
shelters remaining.
What is a potentially abusive tax shelter?
A tax shelter is deemed to be abusive when the tax losses from the tax shelter exceed any possible economic return
from the venture. Abusive tax shelters may be marketing schemes that involve artificial transactions with little or no
economic reality. They often make use of unrealistic allocations, inflated appraisals, losses in connection with
nonrecourse loans, mismatching of income and deductions, financing techniques that do not conform to standard
commercial business practices, or the mischaracterization of the substance of the transaction. Usually, you risk very
little when you invest in an abusive tax shelter, even though it appears otherwise.
How do you know if a tax shelter is an abusive tax shelter?
Abusive tax shelters commonly involve package deals that are designed from the start to generate losses,
deductions, or credits that will exceed the present or future investments. Or the shelter's promoters may promise
that inflated appraisals will enable investors to reap charitable deductions.
The following are important questions to ask yourself if you are considering investment in a tax shelter:
• Do the tax benefits far outweigh the economic benefits?
• Does the investment plan involve a gimmick, device, or sham to hide the economic reality of the
transaction?
• Does the promoter offer to backdate documents after the close of the year? Are you instructed to
backdate checks covering your investment?
Registration and reporting requirements

The Internal Revenue Service requires some tax shelters to register. If registration is required, then the IRS will
assign a tax shelter identification number, which must be given to all investors.
Investors are required to report the registration number on a Form 8271. The Form 8271 is filed along with the
taxpayer's tax return.
Caution: The IRS requires promoters of a registered tax shelter, and other tax shelter arrangements
that are considered potentially abusive, to keep a list of all of their investors for seven years.
If you are an investor in an abusive tax shelter promotion, the IRS may send you a "pre-filing notification letter" if it
determines that it is highly likely that there is:
• A gross valuation overstatement, or
February 03, 2011

• A false or fraudulent statement regarding the tax benefits to be derived from the tax shelter entity or
arrangement
This letter will advise you that, based upon a review of the promotion, it is believed that the purported tax benefits
are not allowable. The letter also will advise you of the possible tax consequences if you claim the purported tax
benefits on your income tax return.
The IRS also requires all investors in tax shelters considered potentially abusive to keep a record whenever they sell
their interest in the tax shelter.
It may be necessary for you to file a Form 8275 (Disclosure Statement) if you are involved in an abusive tax shelter.
You make your disclosure on the form and attach it to your tax return. To disclose a position contrary to a regulation,
use Form 8275-R (Regulation Disclosure Statement).
Penalty provisions
Accuracy-related penalties
A 20 percent accuracy-related penalty can be imposed for underpayments of tax due to:
• negligence or disregard of rules or regulations
• substantial understatement of tax, or
• substantial valuation misstatement
This penalty will not be imposed if you can show that you had reasonable cause for any understatement of tax and
that you acted in good faith.
If an accuracy-related penalty is assessed against you, interest will be imposed on the amount of the penalty from
the due date of the return (including extensions) to the date you pay the penalty.
Negligence or disregard of rules or regulations
The penalty for negligence or disregard of rules or regulations is imposed only on the part of the underpayment that
is due to negligence or disregard of rules or regulations. The penalty will not be charged if you can show that you
had reasonable cause for understating your tax and that you acted in good faith.
Disregard includes any careless, reckless, or intentional disregard. The penalty for disregard of rules and regulations
can be avoided if both of the following are true.
You have a reasonable basis for your position and you made an adequate disclosure of your position.
An understatement is considered to be substantial if it is more than the greater of:
• 10 percent of the tax required to be shown on the return, or
• $5,000
The understatement is the amount of the tax required to be shown on your tax return minus the amount of tax shown
on the return, reduced by any rebates.
Negligence includes any failure to make a reasonable attempt to comply with the provisions of the tax laws, to
exercise reasonable care in preparing a tax return, to keep adequate books and records, or to substantiate them
properly.
The understatement penalty will not be imposed if you can show that there was reasonable cause for the
underpayment caused by the understatement and that you acted in good faith. An important factor in establishing
reasonable cause and good faith will be the extent of your effort to determine your proper tax liability under the law.
February 03, 2011

Valuation misstatement
You may be liable for a penalty if you misstate the value or adjusted basis of property. In general, you are liable for
the penalty if all of the following are true.
• (1) The value or adjusted basis of any property claimed on the return is 200 percent or more of the
amount determined to be the correct amount (2) The price for any property, or use of any property, or
services in connection with any transaction with a related party reported on the return is determined to be
200 percent or more or 50 percent or less of the arms-length price determined to be correct, or (3) The
net adjustment that must be made to transfer prices between related parties in transactions reported on
the return exceeds the lesser of $5 million or 10 percent of the taxpayer's gross receipts
• You underpaid your tax by at least $5,000 because of the misstatement (this amount is increased to
$10,000 in the case of corporations other than S corporations and personal holding companies)
• You cannot establish that you had reasonable cause for the underpayment and that you acted in good
faith
Caution: The penalty is doubled to 40 percent for gross valuation misstatements. A gross valuation
misstatement occurs if the claimed value or basis for property exceeds the correct value or adjusted
basis by 400 percent or more. A gross valuation misstatement also occurs if the price for any
property--or use of any property or services in connection with any transaction with a related party
reported on the return--is determined to be 400 percent or more (or 25 percent or less) of the
arms-length price determined to be correct. This is also true if the net adjustment that must be made to
transfer prices between related parties in transactions reported on the return exceeds the lesser of $20
million or 20 percent of the taxpayer's gross receipts. The penalty rate is also 40 percent if the
property's correct value or adjusted basis is zero.
Civil fraud penalty
If there is any underpayment of tax on your return due to fraud, a penalty of 75 percent of this underpayment will be
added to your tax.
Failure to pay tax
If a deficiency is assessed and is not paid within 10 days of demand, a taxpayer can be penalized up to 25 percent
of the unpaid amount if the failure to pay continues.
Potential problems for corporations

As a result of recent changes to the definition of tax shelters, everyday corporate transactions may become subject
to the IRS tax shelter enforcement if regulations are not carefully drawn.
Should you invest in a tax shelter?

Investors should consult with their tax advisor prior to investing in a tax shelter to make sure that such investment
makes sense for them.
Furthermore, investing in an abusive tax shelter may be an expensive proposition when you consider all of the
potential consequences. First, the promoter generally charges a substantial fee. Second, there may be adverse tax
consequences and substantial amount of penalties and interest (discussed above) if the claimed tax benefits are
disallowed. Therefore you should consider tax shelters carefully, and seek competent legal and financial advice,
before investing.
February 03, 2011

Forefield Inc. does not provide legal, tax, or investment advice. All content
provided by Forefield is protected by copyright. Forefield is not responsible
for any modifications made to its materials, or for the accuracy of
information provided by other sources.
Gleason Tax Advisory

Group, LLC
Joseph Gleason
President
12211 W. Bell Rd.
Suite #203
Surprise, AZ 85378
(623)815-9100
joe@gleasontax.com
www.GleasonTax.com
Page 33 of 33
February 03, 2011
Prepared by Forefield Inc. Copyright 2011

The Ultimate Tax Planning Guide

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The Ultimate Tax Planning Guide

February 03, 2011

What is tax planning for income? ..................................................................................................................5

Why is it important for you to understand the concept of income? ............................................................... 5

Why is it important to know how to generate tax-free income? .................................................................... 5

How can you shelter earned income from taxes? .........................................................................................5

Why should you be aware of strategies to defer taxes? ............................................................................... 5

What are some other tax-advantaged strategies? ........................................................................................5

How can you shift income and tax to others? ............................................................................................... 6

What about Social Security benefits? ........................................................................................................... 6

Generating Tax-Free Income .................................................................................................................................7

What is generating tax-free income? ............................................................................................................ 7

How can IRAs be used to generate tax-free income? .................................................................................. 7

529 plans and Coverdell education savings accounts ..................................................................................7

How can bonds be used to generate tax-free income? ................................................................................ 7

How can life insurance be used to generate tax-free income? .....................................................................8

Other Tax-Advantaged Strategies ......................................................................................................................... 10

What are some other tax-advantaged strategies? ........................................................................................10

Why should you engage in year-end tax planning? ......................................................................................10

Why is it useful to generate capital gains? ................................................................................................... 10

How is investing in real estate beneficial, from a tax standpoint? ................................................................ 10

What is the tax advantage to receiving annuitized payments? .....................................................................11

Tax Planning Tips: Life Insurance ........................................................................................................................ 12

Life insurance contracts must meet IRS requirements ................................................................................ 12

Employer-paid life insurance may have a tax cost ...................................................................................... 12

February 03, 2011

You usually aren't taxed on dividends paid ................................................................................................. 13

Watch out for cash withdrawals in excess of basis--they're taxable ............................................................ 13

You can't deduct interest you've paid on policy loans ................................................................................. 14

The surrender of your policy may result in taxable gain .............................................................................. 14

When in doubt, consult a professional .........................................................................................................14

Tax Planning Tips: Disability Insurance .................................................................................................................15

Individual disability income insurance ...........................................................................................................15

Employer-sponsored group disability insurance ........................................................................................... 15

Benefits under a cafeteria plan ..................................................................................................................... 15

Group association disability insurance ......................................................................................................... 15

Government disability insurance ...................................................................................................................16

Is it wiser to buy disability coverage with pretax or after-tax dollars? ........................................................... 16

Tax Planning for Annuities .....................................................................................................................................17

Taxation of premiums ................................................................................................................................... 17

Tax-deferred growth ..................................................................................................................................... 17

Taxation of premature withdrawals ...............................................................................................................17

Taxation of scheduled distributions .............................................................................................................. 17

Taxation of lump-sum distributions ............................................................................................................... 17

Tax Planning for the Self-Employed ...................................................................................................................... 18

Understand self-employment tax and how it's calculated ............................................................................. 18

Make your estimated tax payments on time to avoid penalties .................................................................... 18

Employ family members to save taxes ......................................................................................................... 18

February 03, 2011

And starting in 2014 ......................................................................................................................................20

Tax Tips: Health Insurance ....................................................................................................................................21

You don't include employer-paid premiums in your income ......................................................................... 21

What if your employer reimburses you for your premiums? ......................................................................... 21

If you're self-employed, special deduction rules may apply ..........................................................................21

Your health insurance benefits typically aren't taxable ................................................................................. 22

Tax Tips: Long-Term Care Insurance ....................................................................................................................23

You may be eligible for an income tax deduction ......................................................................................... 23

The amount of your deduction depends on a few factors .............................................................................23

Watch out--your long-term care insurance benefits may be taxable ............................................................ 24

Sheltering Earned Income from Taxes .................................................................................................................. 25

What is sheltering earned income from taxes? .............................................................................................25

Tax Benefits of Home Ownership .......................................................................................................................... 26