Since 2003, individuals have had a tax incentive to buy stocks that pay dividends. Instead of being taxed at an individual's regular income tax rate as it was in the past, most dividend income qualifies for a highly favorable federal rate. For many investors, the rate difference amounts to a substantial reduction in the tax they have to pay on their dividend income. The Difference The top federal income tax rate on ordinary income (compensation, interest, rents, etc.) is currently 35%. Qualified dividend income, on the other hand, is taxed at a maximum rate of 15% through 2008. In dollars, a rate differential of 20 percentage points amounts to a tax savings of $200 for every $1,000 of dividend income received. An even lower rate of just 5% applies to dividend income that otherwise would be taxed at 10% or 15%. In 2008, the 5% rate drops to 0%, meaning that individuals in the 10% or 15% regular tax brackets will pay no federal income taxes on dividends received in 2008. Holding Period Requirements To ensure favorable dividend treatment, an investor needs to hold the underlying stock (or mutual fund shares) for a minimum period. In general, the minimum holding period is 61 days during the 121-day period beginning 60 days before the stock's ex-dividend date. (A stock's ex-dividend date is the date on which it begins trading without rights to the most recently declared dividend.) Business-related Planning The historically low 15% rate also presents owners of closely held corporations with an opportunity to withdraw earnings and profits (E&P) from their corporations at a relatively modest tax cost. In certain situations, paying a dividend may be highly beneficial from a tax planning perspective. Avoiding termination of an S election. An S corporation that has accumulated E&P from years in which it operated as a regular C corporation can lose its status as an S corporation if, for three consecutive years, the corporation generates net “passive” investment income (e.g., royalties, rents, gains on security sales) that exceeds 25% of gross receipts. Eliminating the E&P by distributing low-taxed dividends would eliminate the corporation's exposure to the passive income restrictions. Avoiding accumulated earnings tax. The IRS can assess an accumulated earnings tax penalty on corporations that accumulate excessive amounts of income to avoid making taxable dividend distributions to shareholders. Because the tax penalty is scheduled to increase significantly after 2008, reducing accumulated earnings by paying dividends could be a useful strategy. back to top

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Club memberships offer business owners and professionals a handy venue for entertaining customers, clients, and prospects. While some of the associated costs may be deductible as a business expense, the tax law generally does not allow a deduction for dues paid to a club organized for business, pleasure, recreation, or other social purposes. What happens when an employer provides an employee with a club membership? In this situation, the employer can turn its dues payment into a fully deductible expense by treating the amount paid to the employee as taxable compensation. Another option for employer-provided memberships: split the dues expense into two parts, one portion attributable to the employee's business use of the club and the other attributable to personal use. The business-use portion is a nontaxable working condition fringe benefit, and the personal-use portion is taxable compensation. With this method, the employer's deduction is limited to the amount treated as compensation. These rules do not apply to memberships in professional organizations, civic clubs, business leagues, or chambers of commerce. Dues paid to these organizations are often fully deductible business expenses. back to top
With the cost of a year's stay in a nursing home averaging $74,095 for a private room and $64,240 for a semi-private room, claiming a deduction for the expense can result in substantial tax savings.* Here's a summary of what taxpayers need to know. Basic rule: The tax law allows a medical expense deduction for nursing home expenses if the primary reason for being in the home is for medical care rather than for personal reasons. If a deduction is allowed, the entire cost, including meals and lodging, is considered a medical expense. Who qualifies: The deduction is available to taxpayers paying their own nursing home costs and to those paying for the care of a spouse or dependent. If you are contributing to the cost of your parent's care, you'll want to find out whether your parent can qualify as your dependent for purposes of the medical expense deduction. Limitations: Note that you must itemize deductions on your tax return to claim medical expenses. The deduction is limited to the amount that, in the aggregate, exceeds 7.5% of your adjusted gross income for the year. *Average cost figures are from The MetLife Market Survey of Nursing Home & Home Care Costs, September 2005. back to top
When today's typical 25-year-olds reach age 65, they will have worked, on average, for seven or more employers.* All that job changing will mean that workers who participate in their employers' retirement plans may face this important decision several times: Should they pocket their savings when they leave or keep the money growing tax deferred? Several Options When plan participants terminate employment (willingly or otherwise), they are typically entitled to a distribution of the vested portion of their retirement plan account. The employee can take the distribution in cash, request that the funds be transferred to another employer's plan or an individual retirement account (IRA), or leave the money where it is (if the current employer's plan permits). Take It? They'll Tax It The government encourages people to keep their retirement savings in tax-deferred accounts when they change jobs. Recent changes in the tax law make it easier for workers to move their retirement savings from one type of plan to another. Conversely, early distributions are discouraged: the tax law imposes a 10% penalty on distributions taken before age 59½ (some exceptions apply).  The penalty is payable in addition to income tax, further reducing the amount available to the employee. Example: Jane is 36 years old and is changing jobs.  She's planning to take the $15,000 in her retirement account to pay off some large bills.  Here's what she'll have after paying the IRS: Jane's vested plan balance $15,000 Income tax (marginal rate = 15%) - 2,250 10% penalty tax - 1,500 Jane's net payout $11,250 Rollover Rewards If Jane rolls over her $15,000 balance instead, and earns an average annual total return of 7%, this is what she might find: Jane's Rollover Amount: Jane's Balance in: 5 years 10 years 20 years 30 years $15,000 $21,038 $29,507 $58,045 $114,184 If you're eligible for a distribution from your retirement plan, think twice before you spend it. * Congressional Research Service Report, “Pension Issues: Lump-sum Distributions and Retirement Income Security,” 8/5/2005. back to top
After a three-year study, the IRS has released final figures on the "tax gap." These figures are based on estimates using 2001 tax year data gather by the IRS's National Research Program (NRP). The tax gap is the difference between what taxpayers owe and what they actually pay. Last year, preliminary numbers from the NRP estimated the tax gap to be between $312 billion to $353 billion. The final numbers show it to be $345 billion for 2001. Figure in inflation, and the probable tax gap for 2005 pushes the $400 billion mark. The IRS reported that $55 million of the 2001 tax gap has been collected through enforcement or was voluntarily paid by taxpayers.  However, the rest has not been collected; for the most part, the reason is that the offenders have not even been discovered. The last time a study like this was done was in 1988. According to IRS Commissioner Mark Everson, 85.5% of tax money that is owed to the IRS is coming in on time. National survey The NRP studied tax returns filed by individuals in 2001. The IRS analyzed each line item and determined what had been misreported. It calculated what was reported on a line compared to what should have been on the line. The NRP revealed that 80% of the gap is due to underreported taxes, while the remaining portion of the gap is due to non-filing and underpayment of tax.  Everson explained that the tax gap results largely from underreporting of income and not overstating deductions.   Key findings Compliance is highest when third-party reporting is required. Among workers, farmers had the lowest level of compliance but contributed only $6 billion to the 2001 tax gap. Other notable gap findings include: Total Non-Business Income:  $56 billion tax gap, Wages, Salaries, Tips:  $10 billion tax gap Total Business Income:  $109 billion tax gap Non-Farm Proprietor Income:  $68 billion tax gap Rents & Royalties:  $13 billion tax gap Complexity is a problem Everson said that the complexity of the Tax Code contributes to the tax gap.  He reiterated the need to reform the Tax Code by simplifying it. Everson predicted that a simplified Tax Code will not only reduce errors but also prevent taxpayers from making intentional errors on their returns. Needed reforms With such a huge tax gap, the IRS recognizes that something has to be done. According to Everson, one fix would be to increase third party reporting, coupled with a refinement of the audit process by updating the audit selection system. These changes are possible because of information gained from the NRP study. The IRS will also close the tax gap by targeting enforcement to improve compliance. Everson indicated that the new results findings will have more of an effect on how audits are conducted rather than how resources are allocated in the examination process. White House proposals The White House has made some recommendations to Congress to improve tax collection. These include: expanding third party information reporting to include certain government payments for property and services expanding third party information reporting on debt and credit card reimbursements paid to certain merchants clarifying liability for employment taxes for employees leasing companies and their clients enhancing requirements  that paid return preparers sign returns and impose penalties for failure to do so; and authorizing the IRS to issue levies to collect employment tax debts prior to collection due process proceedings. Congressional reaction Congressional responses to the tax gap problem are mixed. Senator Max Baucus, D-Montana, and ranking member of the Senate Finance Committee (SFC), said the Bush Administration's proposals to close the tax gap are "unacceptably weak." Baucus recently asked Everson for details about how the IRS plans to close the tax gap. SFC Chairman Charles Grassley, R-Iowa, recognized a serious problem with the tax gap and the difficulties with finding the right solution. "The tax gap numbers show that the only thing harder than measuring the tax gap is finding ways to solve it. There's been a tax gap as long as there's been taxes ...There's no quick, easy solution," Grassley said. back to top