Tax and Business Alert - JULY 2003

Save Taxes with Home Equity Loans

Home equity loans can offer a number of tax-saving opportunities as long as you follow the rules. Home equity indebtedness usually generates fully deductible qualified residence interest. Home equity indebtedness is debt, other than acquisition debt (generally your first mortgage or a refinancing of that mortgage), secured by a qualified residence and not exceeding the lesser of (1) $100,000 ($50,000 for married filing separately), or (2) the fair market value (FMV) of your residence less acquisition debt. As a practical matter, this FMV cap should not come into play if a prudent third party makes the home equity loan. However, some lenders may offer home equity loans exceeding 100% of the value of your residence. For these loans, interest allocable to the debt in excess of your home's FMV cannot be deducted as mortgage interest.

The cap on the debt and the requirement that it be secured by a qualified residence are the only restrictions applying to home equity indebtedness; actual use of debt proceeds is irrelevant. Also, there is no restriction on the number of qualified home equity loans you may have.

Using a home equity loan to finance personal expenses often results in an after-tax borrowing cost that is better than a credit card or unsecured bank loan. Home equity loan proceeds can also be used to purchase an automobile. While interest rates on auto loans are generally lower than rates for unsecured borrowing, the interest is generally not deductible for tax purposes unless the vehicle is used in a trade or business.

While you can generally treat interest expense from up to $100,000 of home equity debt as qualified residence interest, sometimes the debt proceeds are used so that the interest is fully deductible apart from being qualified residence interest [e.g., when used in a Schedule C (sole proprietorship) business activity]. In these cases, it is generally better to elect out of home equity treatment and treat the interest as a business expense. Possible benefits include a reduction in (I) self employment taxes and (2) adjusted gross income (AGI) for purposes such as the passive loss allowance for rental real estate, the itemized deduction phase-out, and other AGI sensitive items.

Example: Electing Out of Home Equity Debt Treatment. Howard takes out a home equity loan for $50,000. He deposits the loan proceeds into a bank account used by his sole proprietorship business. The money is immediately spent on new equipment for the business. Therefore, the interest expense from the $50,000 loan is fully deductible as business interest on his Schedule C. The interest expense reduces his regular and self-employment tax. It also decreases AGI, which may increase AGI sensitive deductions and credits. If Howard treats the $50,000 loan as home equity debt, the interest will be deductible as an itemized deduction for regular tax subject to the itemized deduction phase-out rules. Therefore, Howard should elect out of home equity debt treatment and treat the interest as a business expense.

Planning Point: Homeowners can consolidate part or all of their personal borrowing by obtaining a home equity loan. If properly structured, this recharacterizes nondeductible personal interest expense to deductible qualified residence interest, thus generating tax savings. However, any up-front costs of obtaining the loan must be considered.

Tax Calendar

July 31 - A federal unemployment tax deposit is due if the undeposited liability through June exceeds $ 100. In addition, the second quarter Form 941 (Employer's Quarterly Federal Tax Return) must be filed by today, unless all taxes for the quarter were deposited in full and on time (in which case the deadline is extended to August 11). And finally, Form 5500 is due (unless an extension is filed) for most calendar-year employee benefit or pension plans.

August 15 - Personal returns extended in April need to be filed or extended (to October 15) by today.

September 15 - Third quarter estimated tax payments are due for individuals, trusts, and calendar-year corporations.

If a six-month extension was obtained, calendar-year corporations should also file their 2002 income tax returns by this date.

Selecting a Retirement Plan Beneficiary

A designated beneficiary is a person you name as your retirement plan beneficiary, usually on the form provided by the plan administrator. If you fail to name a beneficiary, the plan document may provide a default provision designating a certain person such as your spouse, as the beneficiary.

A change in beneficiary (while you are alive) generally will not affect the minimum required distributions during your life. For distributions after your death, the final beneficiary designation is made as of September 30 of the year following your death.

For purposes of applying the minimum distribution rules, the designated retirement plan beneficiary must generally be an individual. If an estate or charitable organization is the named beneficiary, minimum distributions after death will be computed as if there is no designated beneficiary.

If you name multiple beneficiaries for your retirement plan assets, the beneficiary with the shortest life expectancy is generally treated as the designated beneficiary for purposes of applying the minimum distribution rules after your death. However, it may be possible to divide the retirement account into individual accounts for each beneficiary. In this case, each individual account will have its own designated beneficiary.

Interesting Websites

Are you shopping for a mortgage and looking for the lowest interest rate available in your area? Mortgage-X Mortgage Information Service at www.mortgage-x.com offers you an easy way to get mortgage rates that are personalized for your specific situation and needs, and find the loan that is really best for you within a few mouse clicks. They maintain a large database, which contains hundreds of the most competitive products. Their mortgage directory presents over 2,500 mortgage companies from across the country. Detailed information on each company is provided.

This website also features a variety of calculators that will help you determine monthly mortgage payments for different types of loans, see complete amortization tables, estimate how much you can afford to borrow, determine the amount of income required to qualify for a loan, and see how bi-weekly payments influence the loan term and the amount of interest paid over the life of the loan.

The Mortgage Bankers Association of America's Buying a Home website at www.mbaa.org/consumer/index.html provides numerous home buying tips. Topics include: A Plain & Simple Guide for First-time Homebuyers; How to Make Shopping For Your Home Easier; Frequently Asked Questions; How Much House Can I Afford; Applying For Your Mortgage; All about Escrows; and, How to Avoid Foreclosure.

Bankrate.com at www.bankrate.com features interest rate information on loans and deposits and general information on various financial institutions. Instructional information is also available on buying a home, refinancing a mortgage, using your home's equity, and more.

Thinking About a Student Loan

With the fall semester approaching, many parents and students are thinking about how they will fund the ever-increasing cost of a post secondary education. With interest rates at record-low-levels, student loans remain a popular way to pay at least a portion of those costs.

Stafford and PLUS loans are available under the Direct and Federal Family Education Loan (FFEL) programs to both students and their parents. Under the Direct loan program, the federal government makes loans available directly to students and parents through schools. Under the FFEL program, private lenders such as banks, credit unions, and savings and loan associations usually make the loans. Whether the student or a parent obtains a Direct or FFEL loan depends on the programs in which the particular school participates.

Subsidized Stafford loans are made to undergraduate and graduate students based on their financial need, but loans cannot exceed certain loan limits regardless of need. The Subsidized Stafford loan is a federal entitlement and the student should receive the full entitlement amount. The federal government pays the interest on a subsidized loan both during the time in school and any authorized deferment period. Unsubsidized Stafford loans are also federal entitlements and can be disbursed automatically, regardless of student need. After a student has borrowed subsidized funds to meet his or her financial needs, he or she can then borrow unsubsidized Stafford loan funds up to the Stafford loan limit.

The amount of borrowing available for a student's undergraduate education depends on the class-level of the student and whether he or she is considered dependent (you support him or her). Dependent undergraduates can borrow up to the following amounts:

· $2,625 for a first-year student enrolled in a program of study that is at least a full academic year.
· $3,500 if the student has completed the first year of study and the remainder of the program is at least a full academic year.
· $5,500 a year if the student has completed two years of study and the remainder of the program is at least a full academic year.

Independent undergraduates or dependent students whose parents are unable (not creditworthy) to get a PLUS loan can borrow up to the following amounts:

$6,625 for a first-year student enrolled in a program of study that is at least a full academic year (only $2,625 of this amount may be in subsidized loans). $7,500 if the student has completed the first year of study and the remainder of the program is at least a full academic year (only $3,500 may be in subsidized loans). $10,500 a year if the student has completed two years of study and the remainder of the program is at least a full academic year (only $5,500 may be in subsidized loans).

All of these are yearly amounts. However, a lesser amount may be loaned if the student receives other financial aid used to cover a portion of the cost of attendance (financial aid cannot exceed the cost of attendance).

Total direct borrowing from all Direct and FFEL program loans combined (including subsidized and unsubsidized) cannot exceed $23,000 for a dependent undergraduate student, or $46,000 (with a maximum of $23,000 subsidized) for an independent undergraduate student.

Graduate students can borrow up to $18,500 per year, of which at least $ 10,000 must be unsubsidized. The total combined undergraduate and graduate debt available to a student is $138,500, of which no more than $65,500 can be subsidized.

The federal PLUS loan program allows parents with good credit to borrow amounts based on the cost of their child's education less any financial aid received.
The student must be a dependent undergraduate student enrolled at least half time. Like Stafford loans, PLUS loans are either Direct or FFEL loans.

Your Executor's Tax Responsibilities

At your death, your executor is responsible for two potential taxpayers; you for income taxes on income earned prior to the date of your death as well as gift and generation skipping transfer (GST) taxes on transfers made prior to your death; and your estate, which may be liable for income taxes, estate taxes, and GST taxes. Your executor must understand that decisions made with respect to elections to claim deductions on the various tax returns could have different impacts on your individual beneficiaries. He or she should take this into account to make certain he or she is fulfilling the duties of fair dealing and impartiality. In many cases, your executor will seek professional assistance to prepare required tax returns and for dealing with taxing authorities and audit issues.

Final Personal Income Tax Return Your executor is required to file a final federal (and state, if applicable) income tax return if your income up to the day you died exceeds the minimum amount for which a return must be filed. If a federal return is required, its due date is April 15 of the year following your death. If you have a surviving spouse, your income through your date of death can be included on a joint return filed for the year of your death.

Estate Tax Return Your executor must file a federal estate tax return if the value of your gross estate plus your prior taxable gifts exceeds $1 million (for 2003, $1.5 million for 2004 and 2005). If a return is required, it must be filed within nine months after your death. Many states require the filing of an estate tax return if a minimum estate valuation level is exceeded.

Gift Tax Return If you had made taxable gifts for which gift tax returns had not been filed, your executor should promptly file the required returns.

Estate Income Tax Return When you die, your estate becomes a separate and distinct taxable entity. This happens whether or not (1) your will has been probated, or (2) a personal representative has been appointed. Your estate will continue in existence throughout the period of administration or settlement, which is the actual time required by your administrator or executor to perform the ordinary duties of administration such as the collection of assets and payment of debts, taxes, and bequests. !t generally continues in existence until all of the assets have been distributed to your heirs and other beneficiaries. Although your executor or administrator is permitted a reasonable period to complete the administration of the estate, this period cannot be unduly prolonged.

Estimated Tax Payments for Estates Generally, your estate is subject to the same estimated tax payment rules as an individual taxpayer. However, your executor does not have to make estimated tax payments for your estate until the first year that ends two or more years after your death.

Executor and Transferee Liabilities Generally, the executor of your estate is personally responsible for your tax liabilities. In addition, a lien for unpaid taxes attaches to all assets of your gross estate for a period of ten years. Any property included in your gross estate is subject to the lien, whether or not your executor has possession of the property (i.e., life insurance proceeds). Therefore, whoever inherits your property (the transferee) may be assessed a tax liability.