It would seem that the issue of whether a person can be a dependent on your 1040 would be a fairly simple issue.  However, that is not the case.  The IRS has some very precise rules regarding who may be claimed as a dependent and the circumstances under which they may be claimed.

The first test that must be met for any person to be claimed as a dependent is the citizenship or resident test.  This test simply states that the person being claimed as a dependent must be a United States citizen or a resident of the United States, Canada, or Mexico for some part of the year.  A non-resident may not be claimed as a dependent regardless of the support you provide or your relationship to that person.

Additionally, the person being claimed as a dependent cannot be claimed by another taxpayer and the person cannot file a joint return (unless there is no tax liability and the filing is only to obtain a refund).

Once that test is met, the person must qualify as a dependent under one of two paths.  They may be a qualifying child or a qualifying relative.  In addition, there are special rules for children of divorced or separated parents.

There are four tests that must be met to be a qualifying child.  All four must be met in order to be claimed as a dependent.

The relationship test requires that the person being claimed as a dependent be your son, daughter, stepchild, foster child, brother, sister (including half and step brothers and sisters) or a descendent of any of them.  Therefore, your grandchild as well as your niece or nephew would also qualify.

The age test states that the child must be under age 19 at the end of the year or a full-time student under age 24 at the end of the year.  Note that the date of determination is December 31.  A child turning 19 at any time during the year who is not a full time student does not qualify.

A child is defined as a full-time student if he or she is a full-time student as defined by the institution for part of five months during the year.

There is an exception to the age rule for permanently and totally disabled children.  They would qualify regardless of age.

The residency test requires that the child must have lived with you for more than half the year.  Temporary absences, such as for illness, education, vacation, business, or military service count as time lived with you.  A child who is born or dies during the year is treated as having lived with you for the entire year if they were alive at any time during the year.

The support test is met if the child did not provide more than half of his or her own support during the year.  Scholarships are not considered support provided by the child.

In the case of separated or divorced parents, the custodial parent is usually considered the one who qualifies for the exemption.  The custodial parent may sign a written declaration that he or she will not claim the exemption and is allowing the noncustodial parent to take the exemption.  Additionally, if there is a qualified domestic relations order specifying who gets the exemption, the IRS will normally abide by that order.

If the would-be dependent does not meet the criteria for a qualifying child, it may be possible to claim the person as a qualifying relative.  This is somewhat of a misnomer, as the person does not have to be a blood relative to qualify under these rules.  Additionally, there is no age limit for meeting the qualifying relative criteria.

The first test is that the person cannot be a qualifying child of any other taxpayer.

The member of household or relationship test has two sections.  First, the person must live with you as a member of your household for the entire year.  As with the residency test under qualifying child, temporary absences for specified reasons count as living with you.    Second, there is an exception.  Certain relatives do not have to live with you to qualify under this test.  These include your child, stepchild, foster child or any descendent of them; your brother or sister (including half and step); your parents or other direct ancestor; aunt, uncle, niece, or nephew.  Any of these relationships that were established by marriage are not ended by death or divorce.

The gross income test specifies that the person’s gross income for the year be less than the amount of the dependency exemption.  For 2010, this is $3,650.  Gross income is “all income in the form of money, property, and services that is not exempt from tax.”  Thus, income such as social security is not included in gross income for this purpose.

Finally, the support test requires that you provide over half the person’s support during the year.  If no one provides over half the support, those supporting the person may enter into a multiple-support agreement under which one person is designated as having permission to claim the dependency exemption.

I would add that there is one other specification under the IRS rules.  In order to claim the dependency exemption, the relationship between the parties must not be in violation of state or local law.  For example, if a person has multiple wives, state laws against polygamy would serve to prevent the husband from claiming multiple wives as dependents.

Hopefully, this has shed some light on the topic of dependency exemptions.  It is by no means exhaustive, as there are an unlimited number of situations that do not always fit the rules perfectly.

Having just attended the IRS Nationwide Tax Forum in Atlanta, I picked up a great deal of information, some of which will be the subject of future blog posts.  However, I am going to devote this space today to some observations and quick comments from the Forum.  It was apparent, from observation, that tax return preparers are not happy with changes that the IRS is bringing forth and with the increased complexity of the tax code.  In one session dealing with the tax implication of the recently-enacted health reform legislation, those in attendance burst out with shouts of “repeal it,” “don’t bother issuing regulations, it will be repealed before you get them issued,”  and other comments.

Mandatory E-filing As most of my readers know, in 2011, it has been legislated that all returns filed by a paid tax preparer must be e-filed.  However, the IRS has modified that requirement slightly.  In 2011, any preparer who expects to prepare 100 or more returns must submit the returns via e-file.  In 2012, that requirement tightens up so that any paid preparer who expects to prepare 10 or more must e-file.  The original legislation stated that the returns filed by the preparer must be e-filed.  The IRS has interpreted this so that filing equals preparation.

However, the IRS has created an opt-out provision.  Any taxpayer who does not want his or her return e-filed can inform the preparer that they choose to opt-out of having the return submitted via e-file.  This is a matter between the preparer and the taxpayer, the IRS does not plan to issue a form on which a taxpayer can opt out.  However, my advice is that all preparers should get a signed statement from the taxpayer, indicating the desire to opt out.  This will protect the preparer in the event the IRS inquires as to why the preparer is not e-filing certain returns.

Emphasis on Enforcement I cannot tell you how many times I heard the word “enforcement” uttered by IRS personnel at the Forum.  However, I can tell you that I heard “service” mentioned once.  With the large budget deficits, and pressure to reduce the tax gap, the IRS is on a major enforcement initiative.  Wherever the IRS perceives that there are significant uncollected tax dollars, there is likely to be an increased emphasis on collection in that area.  Having said that, I do not recommend that taxpayers avoid taking legitimate deductions in the hope of avoiding an IRS investigation.  Take any deduction you are entitled to.  But the critical factor is to maintain good records of all expenditures and receipts so you can successfully defend yourself against an IRS audit.

Internet Fraud The IRS is taking steps to reduce fraud via the internet.  You should know that the IRS does not contact taxpayers via e-mail and does not ask that personal information be entered on their internet website.  Additionally, there are websites out there that will allow you to prepare your taxes online, submit them by e-file, and have your refund direct deposited to your account.  These unscrupulous websites, however, change your bank account number before the return is filed, so that your refund goes to them.  Know who you use to prepare and file your taxes.

Paid Preparer Registration The IRS is registering paid preparers.  Starting in the Fall, any preparer must obtain a preparer taxpayer identification number (PTIN).  If a preparer already has a PTIN, they must re-register, but can keep the same number.  Registration will require a fee, currently estimated by the IRS to be between $75 and $300 every three years.  This is not a popular topic with preparers.  In one session I attended, those in attendance booed the IRS representative when she was discussing this topic.  In addition, registration will require preparers who are not CPA, Attorneys, or Enrolled Agents to pass a test and take continuing education in order to maintain their registration.

Many changes are coming in the area of taxation, and they are coming soon.  From the standpoint of a preparer, there is much to be done in order to stay current on the latest from the IRS.  For the taxpayer, you should carefully select who you choose to prepare your taxes.

The recently-enacted “Patient Protection and Affordable Care Act” and the “Health Care and Education Reconciliation Act of 2010” changes the health-care landscape in the United States.  Evaluating the effectiveness of the legislation is not my purpose here.  What many people do not realize is that there are several far-reaching effects on the tax code, both for individuals and for businesses.  In this article, we will look at some of the tax code changes for individual taxpayers.

Some of the changes will be effective beginning in 2011, other changes will be phased in over a number of years.  Two provisions, however, are effective immediately.  In the past, parents could include their children on their health insurance policy up to age 23.  Under the Reconciliation Act, the definition of dependent is changed to allow parents to carry their children on the policy to age 27.

Second, the Patient Protection Act allows the IRS to disclose taxpayer information upon written request of the secretary of Health and Human Services or from the commissioner of Social Security.   This took effect with the implementation of the legislation.  This erosion of taxpayer privacy should be a matter of great concern.

Effective January 1, 2011, the Patient Protection Act does not allow reimbursements for over-the-counter medicines from health savings accounts (HSAs), Archer medical savings accounts (MSAs), Health FSAs, or other health reimbursement arrangements.  Qualified medical expenses for drugs are defined as a prescribed drug.   A second provision in the act also takes effect this coming January, increasing the penalty for unqualified distributions from HSA or Archer MSA accounts to 20%.

Several major provisions of the legislation become effective January 1, 2013.  Today, most people cannot take an itemized deduction for medical expenses on Schedule A, as only those expenses that exceed 7.5% of adjusted gross income can be deducted.  This threshold increases to 10% of AGI beginning in 2013.  There is an exception for taxpayers or spouses who turn 65 before the end of the tax years 2013-16.  For these taxpayers, the threshold remains at 7.5%.  Deductions for medical expenses will become almost non-existent with this threshold.

A second provision that becomes effective in 2013 is an increase in the current 1.45% Medicare tax.  This is increased by 0.9% on wages that exceed a threshold amount.  In an interesting twist, the tax is imposed on the combined wages of the taxpayer and spouse in the case of a joint return.  The threshold amount is $250,000 for joint filers, $125,000 for married filing separate, and $200,000 for all others.

The Medicare tax is given an additional expansion as a 3.8% tax will be applied to the lesser of an individual’s net investment income or a modified adjusted gross income that exceeds a threshold amount.  This threshold is the same as for the additional tax in the previous paragraph.

The year 2014 will see the beginning of two of the major features of the Patient Protection Act, both involving the tax code.  The premium assistance credit is a refundable tax credit that eligible taxpayers can use to help cover the costs of premiums for health insurance purchased through a state health benefit exchange.  Each state is required to establish such an exchange.  The credit will be paid directly to the insurance plan or the taxpayer can choose to pay the premium and claim the credit on the 1040.

The second provision taking effect in 2014  levies a tax on uninsured individuals.  It is this aspect of the bill that is being challenged by the Attorneys General of several states as being unconstitutional.  The Act requires U. S. citizens and legal residents to maintain minimum amounts of health insurance coverage.  When fully implemented, failure to carry the minimum amount of insurance will subject taxpayers to a tax of $695 per individual or 2.5% of the amount by which your household income exceeds the minimum income required for filing a return.  The tax is the greater of these two.  This feature phases in, and will not reach these levels until 2016.  This appears to be a provision that is short on enforcement as liens and seizures of the taxpayer’s property are not authorized to enforce the penalty and non-compliance is not subject to criminal penalties.

There are three non-health care aspects of the bill that will have an impact on individuals.  Beginning in 2011, the adoption credit has been expanded by $1,000 to $13,170, and will be indexed for inflation.  A second provision levies a 10% tax on the use of indoor tanning services.  This tax is to be paid by the user, collected by the tanning facility.

Finally, an important feature codifies the economic substance doctrine.  For those who are not “tax nerds” this probably carries very little meaning.  The economic substance doctrine was established by the courts many years ago.  Since it was neither a legislative enactment nor a treasury regulation, there has been a great deal of uncertainty surrounding this doctrine.  The economic substance doctrine states that a transaction must change a taxpayer’s position in a meaningful way apart from the tax benefits and the taxpayer has a substantial (non-tax) purpose for entering into the transaction. Failure to demonstrate that a transaction has economic substance can now subject the taxpayer to penalties.

In my next posting, I will discuss the effect of these two pieces of legislation on businesses.

It seems that more and more people are working in one state and living in another.   Or, they may be working in multiple states during the year.  This creates problems when filing state income tax returns at year-end.  While each state has laws that differ in regard to taxation of income earned by non-residents, there are a few principles that tend to be common among the states.

First, you are subject to tax on all your income in your state of residence, regardless of where it was earned.  Basically this means that whatever income is reported on your Federal 1040 will be reported on your return for your state of residence unless it is exempt income.  You would file as a full-year resident.  You will also be subject to income tax in the state in which the income was earned.  You will need to file as a non-resident, reporting only the income earned in that state.

Fear not, however. You will not normally pay tax on the same income to both states.  As a rule, your state of residence will grant you a credit for state taxes paid to the other state.  However, this is not necessarily a dollar-for-dollar credit.  You home state will tax the income at its regular rate.  The credit will only be granted for the amount of tax that you would have paid if earned in your home state.  In other words if the tax rate in the non-resident state is higher, you will not get a full credit in your state of residency.

There are some exceptions to this rule.  Some states have reciprocal agreements that specify if you work in one state and live in another you do not pay tax in the state where you work.  For example, workers in Washington, D. C. who are not residents are exempt from the D. C. income tax and pay the tax in their state of residence.   Other states may not grant a credit for state taxes paid to certain other states.

A second multi-state situation occurs when you move your residence from one state to another during the year.  In these cases, you generally file as a part-year resident in each state, reporting the income earned in each state on that state’s respective return.  Your deductions, exemptions, and credits are normally allocated based on the length of time you were a resident of that state.

In some cases, special laws are applicable to those moving out of the state.  For example, Federal law allows you to exclude up to $250,000 ($500,000) of gain on the sale of your principal residence if you qualify.  Most states also have this exclusion, but if you move out of the state, the gain may be taxable income.

Some states have separate forms for part-year or non-residents.  Others just have separate schedule as a part of their regular individual return.   Since the laws vary so significantly from state-to-state check with a local tax preparer or the state revenue department to determine your filing obligations.  Finally, I would add that, in our present economic situation, states are looking for every dollar of revenue they can get, so they are likely to be aggressive about making certain they collect the amount of tax they feel is owed to them.

The devastation from the earthquake in Haiti has been felt by all of us.  The outpouring of aid to that impoverished island nation has been unprecedented.  But the needs have also been great.  Politics has been put aside, those of the liberal and the conservative persuasion have rallied to assist in the tragedy that has impacted Haiti.

In a rare move, Congress has passed legislation to encourage contributions for the relief efforts in Haiti.  Charitable contributions made for the relief of earthquake victims in Haiti may be deducted on your 2009 income tax return, rather than waiting to take the deduction on your 2010 return.  Normally, a deduction is allowed only in the year in which the expenditure is made.  Based on the language in the legislation, it is not mandatory to deduct it in 2009.  If you choose to wait until 2010 to take the deduction, that is acceptable.

Four conditions must be met in order to deduct the contribution in 2009:

• The contribution must be made after January 11, 2010 and before March 1, 2010.
• The contribution must be a cash contribution.  This simply means that the contribution cannot be in goods such as food or clothing.
• The contribution must be for the relief of victims in areas affected by the Haitian earthquake on January 12, 2010.
• All other usual requirements for deducting charitable contributions are met.  Primarily, this means that the contribution must be made to a qualified charitable organization.  If you are in doubt you can check the IRS list.  This list of qualified charitable organizations is published in IRS Publication 78, or it may be viewed at http://www.irs.gov/charities/article/0,,id=96136,00.html.

Since a number of contributions are being made via dialing a cell phone number, the IRS will accept a telephone bill showing the name of the organization, along with the date and amount of the contribution as meeting the recordkeeping requirement.

I would encourage you to donate, but do so wisely.  Be certain that the organization to which you donate will use those contributions for timely relief to Haiti.  On a personal note, I would encourage donations to His Nets, Inc. (www.hisnets.org).  His Nets distributes insecticide-treated mosquito nets to help prevent deaths from malaria.  His Nets has people in Haiti, and anticipates getting nets to the people in a matter of days.  People are having to sleep outside, and in doing so, are at risk of contracting malaria.  A net can help prevent these deaths.  One net costs $6.00.  I am treasurer of this organization, and I can assure you that every dollar you give His Nets for Haitian relief will go toward the purchase of nets.

2009 was a year that saw a number of changes in our tax laws.  Some of these changes are permanent, others are in effect only for a limited period of time.  I will discuss here some of the more important ones, but this is by no means an exhaustive list.

If you bought a new vehicle between February 18, 2009 and December 31, 2009, you can deduct the sales tax paid even if you don’t itemize your deductions.  It must be a new vehicle, and the tax deduction is limited to taxes on the first $49,500 of cost of the vehicle.  Passenger automobiles and light trucks qualify if under 8,500 pounds gross vehicle weight; motor homes have no weight limit; and motorcycles that do not weigh more than 8,500 pounds all qualify.  You may also deduct $500 ($1,000 married filing jointly) of property taxes on your residence if you do not itemize.  A new form Schedule L is available for those taking the standard deduction, but with adjustments such as these two items.

The first-time homebuyer credit has been extended and expanded.  A first-time homebuyer is eligible for a credit of up to $8,000 on homes under contract before May 1, 2010 and closed by June 30, 2010.   Income limits are $225,000 for taxpayers filing jointly; for others, it is $125,000.  Due to widespread fraud, a copy of the closing statement must be attached to the return.

If you have a traditional IRA, 2010 might be a good year to convert it to a Roth IRA.  Qualified withdrawals from a Roth are tax free.  However, taxpayers whose income exceeded $100,000 have been prohibited from converting to a Roth IRA.  Beginning in 2010, that limit is permanently removed.  When a traditional IRA is converted to a Roth, you must pay taxes on the amount converted.  However, for 2010 conversions, the tax may be paid in 2011 and 2012.

If you end up owing taxes on your 2009 return, you might want to examine your withholding.  In 2009 and 2010 taxpayers are eligible for the Making Work Pay Credit, which is equal to 6.2% of your earned income, limited to $400.  However, withholding tables were adjusted to reflect this credit, so if you are not eligible for the full credit, or your withholding was adjusted for a greater amount than the credit, you may end up with a smaller refund or having to pay.

The Hope Education Credit has been renamed and expanded.  It is now the American Opportunity Credit.  It is a credit of up to $2,500 for qualified education expenses paid but is not limited to students in the first two years of college.

I would remind you that you must have a receipt for a charitable contribution of any amount.  The old $250 law has been repealed.  For contributions of property you must get an acknowledgement of the donation from the charitable organization, but it is your responsibility to place a value on the contribution.  Programs such as “It’s Deductible” and “Deduction Pro” can be very helpful in determining the correct amount to deduct.  If your non-cash contributions are over $500 you must complete Form 8283.  Mileage driven for charitable organizations is deductible at 14 cents per mile, this amount is unchanged for 2010.  You can also deduct any out-of-pocket expenditures on behalf of a charitable organization, but you cannot deduct the value of your time.  I would also add that contributions made to charitable organizations that are designated for specific individuals or purposes may not be deductible.

With so many people experiencing economic difficulties it is not uncommon for someone to help out by paying the mortgage payment or property taxes for a friend or relative.  I would remind you that, in order to deduct mortgage interest or property taxes, you must be legally liable for the amount and you must make the payments.  If both criteria are not met, you cannot take a deduction.

Mileage rates for 2009 are 55 cents per mile for business, 24 cents for moving or medical miles, and 14 cents for charitable mileage.  In 2010 the business rate drops to 50 cents, the moving and mileage rate to 16.5 cents, and the charitable rate is unchanged.

A couple of other items are not changes for 2009, but are some things to consider in your tax planning.  If you are offered disability insurance through your employer and your employer pays the premium any benefits you receive will be fully taxable.  However, if you pay the premium any benefits are tax-free.

I would also remind you that the IRS does not correspond with taxpayers via e-mail, so if you get an e-mail that purports to be from the IRS, delete it immediately, as it is spam.

Finally, a few tips about paid preparers.  First, if you pay to have your return prepared, be certain the preparer signs as paid preparer.  To fail to do so is illegal, and you cannot raise the defense that your prepare did not complete your return properly if it is not signed.  Secondly, I would also advise you to have your return prepared by a CPA or Enrolled Agent.  These two categories of preparers, along with attorneys and actuaries  are the only individuals allowed to practice before the IRS.  This means that preparers in these categories may represent you in an IRS audit situation.  Otherwise, you are on you own.  Third, keep in mind that the preparer is not an auditor of your return.  If there has a question about the validity of an item you submit, your preparer should make reasonable inquiries about that item.  But ultimately, whatever goes on your return is your responsibility.

In closing, I feel somewhat like Bob Erickson.  Annually, at the IRS Nationwide Tax Forums, Bob’s assignment is to give an overview of changes in the tax law for the current year.  Once he confessed that his recurring nightmare was that some year would arrive and he would have nothing to talk about.  Then, he said, he woke up and realized that would never happen.  This is where we are now.  It does not appear that any more changes will be enacted for 2009.  But Congress has a whole year ahead to make changes that will require us to keep  busy staying abreast of what’s new.  Change will happen.

In 2009 and 2010, taxpayers may receive a tax credit for energy efficient improvements made to their principal residence.  However, you need to be very careful to make certain that all the provisions of the law are met, as this is a detailed piece of legislation with specific requirements.

Generally, you can deduct up to 30 percent of the cost of qualifying improvements up to a maximum of $1,500.  Unfortunately, the $1,500 limit is a combined limit for 2009 and 2010.  Qualifying improvements include insulation, windows, doors, fuel cells, roofing, heating and air conditioning units, water heaters, geo-thermal heat pumps, biomass stoves, solar energy systems (but not for pools), and small wind energy systems.

The improvement must be placed in service between January 1, 2009 and December 31, 2010.  The improvements generally must be for the taxpayer’s principal residence.  However, geothermal heat pumps, solar panels, solar water heaters, fuel cells, and small wind energy systems qualify if installed in a second home.  The credit for windows, doors, insulation, roofs, heating and air conditioning, or non-solar water heaters is not available for new construction.

Energy standards for the current credit are more stringent than for the 2007 credit.  The manufacturer must certify that the improvement meets the standard and must provide a written statement to that effect.  The statement may be in printable form on the manufacturer’s website.

In order to take the credit, Form 5695 should be completed and included with your 1040.  The credit is to be taken in the year the improvements were made.

There are two credits for the purchase of certain energy-efficient vehicles.  The credit for hybrid gasoline-diesel, diesel, battery-electric, alternative fuel, and fuel cell vehicles varies in amount.  The credit is based on a formula determined by the vehicle weight, technology, and fuel economy.  It is limited to the first 60,000 vehicles per manufacturer.  The credit for Toyota and Honda has been phased out at this time.

The second vehicle credit is between $2,500  and $7,500 and is for plug-in hybrid electric vehicles.  The amount of the credit depends on the capacity of the battery system.  It is effective for vehicles purchased between January 1 and December 31, 2009. It has been extended beyond that date but phases out based on the number of vehicles sold by the manufacturer.

It is obvious that the energy credits are not simple credits to take on your tax return.  Foremost, you should be certain that the property being purchased will qualify for the credit. For the residential energy credits, it must be in writing.  For vehicles, ascertain that the credit for the particular vehicle is still available.  Forms for claiming the credit vary depending on the specific credit that you are taking.

Beginning in 2010 anyone is eligible to convert a traditional IRA or 401(k) plan into a Roth IRA.  Up to this point Roth’s were not for everyone, as there were two limitations on having a Roth IRA.  The first limitation prohibited contributions to a Roth if your adjusted gross income was in excess of $110,000 (or $160,000 married filing jointly).  The second limitation prohibited anyone with an adjusted gross income exceeding $100,000 from converting an existing traditional IRA or 401(k) to a Roth account.  Starting next year, anyone can convert a traditional IRA or a 401(k) plan to a Roth IRA without regard to income level.

Roth IRA’s can be very attractive retirement vehicles, as all qualified withdrawals from the account are tax free.  That’s right.  Make a non-deductible contribution to a Roth IRA today and never pay tax on that money again –not on the amount deposited nor on the earnings in the account.  In addition, there are no required distributions from a Roth IRA regardless of age.  If you don’t need the funds that are in the Roth account leave them there and your heirs will not pay tax on it either.  A Roth account must have been in place for five years prior to any withdrawals to receive the tax-free benefit.

Another advantage of a Roth account applies to working taxpayers over age 59 ½ who established their Roth more than five years ago.  Since there are no taxes to be paid and no requirements about withdrawals, this group of taxpayers can use a Roth as a tax-free savings account.

If you have contributed to a deductible IRA, you must pay tax on the amount converted.  So, if you have $50,000 in your IRA and wish to convert it to a Roth, you must include $50,000 in your taxable income.  If you have contributed to a non-deductible IRA, you would only pay tax on the earnings on the withdrawal when converting to a Roth. If you made $30,000 in  non-deductible contributions that have grown to $50,000, you would pay tax on $20,000 only.  From the point of withdrawal, any additional earnings would not be subject to tax.

Although the $100,000 limit has been permanently removed, there is a unique opportunity in 2010. For any conversion that is completed in 2010, the taxes on the conversion can be deferred and spread over two years, 2011 and 2012.

So, should you convert your existing traditional IRA to a Roth?  Unfortunately, there is no one correct answer to that question other than “It depends.”  Without doubt, anyone with more than ten years until retirement should consider such a move.   There should be a significant amount of growth in the account prior to retirement and tax rates are likely to increase over time.  Paying taxes now at a lower rate and on fewer dollars makes sense.  The remaining issue is your ability to pay the extra tax at this time.

For taxpayers closer to retirement, the choice is not as clear-cut.  There is likely  be an advantage to anyone converting regardless of the time span – assuming the market increases.  Probably the worst scenario is to convert to a Roth account, only to see the value of your account decline.

Assuming the market does not go into a decline you must weigh several factors in the decision to convert.

• How soon do you anticipate retirement and use of the funds?  In other words, how much opportunity is there for the money in your account to grow?  The longer the time frame, the greater the benefit to be obtained by converting.
• How does your tax situation compare now to when you are retired?  Will your marginal tax rate decline upon retirement?  If so, it might be more advantageous to keep  the traditional IRA and pay tax on your marginal rate in retirement.  Keep in mind that converting to a Roth could place you in a higher tax bracket for the year of conversion, resulting in more tax being paid.
• Without regard to your current marginal rate, what do you anticipate for the future?  The current individual tax rate structure is historically low.  Remember that in the early 1960’s the top marginal rate was 91 percent, a far cry from today’s 35 percent.  Considering that the federal government is currently running historic deficits, it is not wild speculation to think that rates may increase in the future.
• A final issue is your ability to pay the additional tax in the year of conversion.  If you do not have the cash available or must borrow the money to pay the extra tax, converting is probably not a wise move.

As stated earlier, the answer is not a “one size fits all.” You will need to take a hard look at your financial situation and expectations about the future to make an intelligent choice.  Your financial  professional can assist you in modeling various scenarios and help you make the right choice.

The first-time homeowner credit has been extended and expanded.  On November, 6, 2009, President Obama signed the “Worker, Homeownership, and Business Assistance Act of 2009.”  This act extends the first-time homeowner credit for taxpayers who have had no ownership interest in a principal residence for the past three years.  In order to receive the credit, the taxpayer must enter into a binding contract for the purchase before May 1, 2010 and must close on the purchase before July 1, 2010.

In addition, the act includes a $6,500 credit to taxpayers who already own a principal residence.

A taxpayer who has owned and used the same principal residence for five of the past eight years qualifies for this credit.  The new home must be under contract before May 1, 2010 and the closing must occur before July 1, 2010.

Like the existing $8,000 credit, this amount is refundable and does not have to be repaid.  Refundable means that you will receive the total amount of the credit you are qualified for even if your tax liability is less than the credit amount.  For example, if your tax liability is $5,000, the credit would reduce that to zero and refund you $3,000 plus any withholding that occurred during the year.

For sales occurring after November 1, 2009, the full credit is available to single taxpayers whose income is under $125,000.  For couples filing a joint return, the limit is $225,000.  Above these limits, a partial credit may be available.

For homes purchased after December 31, 2008, the buyer may treat the purchase as occurring on December 31 of the prior year.  In other words, if a home is purchased during 2009, it may be treated as occurring on December 31, 2008; a home purchased in 2010 may be treated as occurring on December 31, 2009 for tax purposes.

Due to widespread fraud in the current credit, a documentation requirement has been added.  In order to receive the credit, a properly executed copy of the closing (settlement) statement must be attached to the return.

Anyone who has claimed the credit in the past and was not eligible for the credit should file an amended return, returning the credit to the IRS.  Numerous instances of fraud in claiming the credit have surfaced, and the IRS is aggressively pursuing these cases.

In a reinforcement of something that everyone probably realizes already, the 1040 is getting more complicated.  The IRS has now included Schedule L as a part of the 1040 package.  This new form is entitled “Standard Deduction for Certain Filers.”  For as far back as I can remember, the standard deduction was a single line item on the 1040.  Now, thanks to Congress’s tinkering with the tax code, we have a 21-line form to help us determine the amount of our standard deduction.

The standard deduction was supposed to make filing your 1040 simpler.  You did not have to keep up with any receipts, do any calculations, just determine your filing status and plug in the correct amount.

In my opinion, there are two reasons why this is happening.  First, and probably foremost, Congress cannot resist tinkering with the tax code.  This is also a reason why we will never attain true tax simplification.  Suppose for a minute that Congress passed a flat tax.  No deductions, no exemptions, just a set percentage tax on all your income.  It would not last.  Congress could not resist the temptation to carve out a tax benefit for this reason or that reason and the flat tax would be gone.

The second factor in the increasingly complicated tax code is the computer.  As a long-time tax preparer I remember the days of preparing tax returns by hand.  If I had to complete a 1040 by hand today, I would get out of the business.  Most returns have simply gotten too complicated to prepare without the assistance of a computer and good tax software.  As computer-generated returns have become more common, simplification has gone out the window.  So what if the return calculation is difficult?  Let the computer do it.