Municipal bond funds may be a cure for tax headaches

As you work on your tax return for 2000, you may be surprised to see how much taxable investment income you incurred last year--and how much in taxes you'll pay this year. If that's the case, consider switching some of your fixed-income investments to municipal bond funds, which pay tax-exempt income.

"The first step," says Kathleen Stepp, a CPA and financial planner with Stepp & Bothwell, in Overland Park, Kansas, "is to determine whether your tax bracket is high enough to make municipal bonds appropriate. If you're in a 15% bracket--the lowest federal bracket--then I wouldn't advise investing in tax-exempt bonds."

In 2000, single taxpayers with up to $26,250 in taxable income were in the 15% bracket, which jumps to $43,850 for joint filers. Above that, tax brackets range from 28% to 39.6%, where municipal bonds may make sense. "The higher your bracket," says Stepp, "the greater the benefit you'll get from individual municipal bonds and muni bond funds."

Still, how can you choose among the 1,845 municipal bond funds tracked by Chicago-based Morningstar Inc.?

National vs. single-state funds. Start by choosing between funds that hold bonds issued around the country and funds with bonds issued only in your state, says Eric Jacobson, a senior analyst at Morningstar. National funds provide diversification, while single-state funds usually deliver income that's exempt from state (and perhaps local) tax as well as federal tax. Thus, after-tax income probably will be higher from a single-state fund. "Single-state funds are riskier," explains Jacobson, "because they can lose value more easily if your state's economy turns down sharply." He adds that many people are attracted by the diversification of national funds, but investors in high-tax states such as California, New York, and Massachusetts may prefer single-state funds.

Short- vs. intermediate- vs. long-term bonds. Some muni funds hold bonds maturing in a few years while others have average maturities of 10 years, 20 years, or more. "Longer-term funds usually have higher yields and may provide greater long-term returns," says Jacobson, "but they have more risk too. If interest rates go up, long-term funds probably will lose the most value." That is, a fund with a share price of $20 might fall to $19 or $18 or go even lower, if rates rise. "I prefer short-term muni funds for clients who will need the money fairly soon, perhaps for a tax payment or a college bill," says Stepp. "For longer-term needs t probably would recommend individual bonds. If you buy and hold individual bonds until maturity you know that you'll get your money back."

High-yield vs. high-quality funds. Like corporate bonds, municipals include junk bonds as well as highly rated issues. As you'd expect, junk muni funds pay higher yields but they pose greater risks. In late 2000, for example, Eaton Vance National Municipals Fund (EVHMX) was yielding 5.6%, according to Morningstar, while its sister, Eaton Vance Municipals Trust II: Eaton Vance High Yield Municipals Fund (ETHYX), was yielding 6.5%. On a $50,000 investment, that would be an extra $450 in interest per year. Extra income is appealing but there's no free lunch. "High-yield muni funds may have inherent risks that are not apparent," says Jacobson. "If they hold bonds that are not frequently traded, for example, such funds could experience volatility not related to any fundamental bond traits."

"Look for a fund with an experienced manager, a good record, and very low expenses," says Richard Hammel, managing partner at Hammel Financial Advisory Group in Nashville, Tennessee. For example, Vanguard Insured Long-Term Tax-Exempt Fund (VILPX) has an expense ratio of 0.20% (on a $50,000 holding, your expenses would be $100 per year).

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Stimulation Plan Impacts Your Business

As a restaurant expert and trainer, I know a TON about the restaurant business and how to make it work for you and other independent restaurant owners like you. But I’m not a tax expert. My good friend and accountant, Tonetta Weaver, is kind enough to keep some of us up to date on newsworthy information from the IRS. I thought this was a good bit of information and wanted to pass it along to you.

From the IRS Newswire…

2008 Economic Stimulus Act Provides Tax Benefits to Businesses

WASHINGTON — In addition to providing stimulus payments to individuals, the Economic Stimulus Act of 2008 provides incentives to businesses. These incentives include a special 50-percent depreciation allowance for 2008 purchases and an increase in the small business expensing limitation for tax years beginning in 2008.

50-Percent Special Depreciation Allowance

Depreciation is an income tax deduction that allows a taxpayer to recover the cost or other basis of certain property over several years. It is an annual allowance for the wear and tear, deterioration or obsolescence of the property.

Under the new law, a taxpayer is entitled to depreciate 50 percent of the adjusted basis of certain qualified property during the year that the property is placed in service. This is similar to the special depreciation allowance was previously available for certain property placed in service generally before Jan. 1, 2005, often referred to as “bonus depreciation.” To qualify for the 50 percent special depreciation allowance under the new law, the property must be placed in service after Dec. 31, 2007, but generally before Jan. 1, 2009.

To reflect the new 50-percent special depreciation allowance, the IRS is developing a new version of the depreciation and amortization form for fiscal year filers. The new form will be designated as the 2007 Form 4562-FY.

Section 179 Expensing

In general, a qualifying taxpayer can elect to treat the cost of certain property as an expense and deduct it in the year the property is placed in service instead of depreciating it over several years. This property is frequently referred to as section 179 property, after the relevant section in the Internal Revenue Code.

Under the new law, a qualifying business can expense up to $250,000 of section 179 property purchased by the taxpayer in a tax year beginning in 2008. Absent this legislation, the 2008 expensing limit for section 179 property would have been $128,000. The $250,000 amount provided under the new law is reduced if the cost of all section 179 property placed in service by the taxpayer during the tax year exceeds $800,000.

The new law does not alter the section 179 limitation imposed on sport utility vehicles, which have an expense limit of $25,000.

TAX CODE CHANGES THAT CAN AFFECT YOUR RETURN!

The United States tax code is constantly being changed and updated by Congress. Therefore it is essential to stay informed on recent tax changes and how they might affect your next income tax return.

To help our visitors stay prepared this tax season we have put together this list of 12 tax code changes that might affect your tax return.

1. Foreclosure Relief

Over the past year the federal government finally did something to help the thousands of families getting hit with huge tax bills after loosing their house due to foreclosure. According to recent law changes, debt forgiven by a foreclosure, short sale, or loan restructure will no longer be treated as income. The IRS will now allow for up to $2 million of forgiven debt to be excluded from a person’s income. However, it is important to note that this law change only applies to homes used as a principal residence. Vacation homes and property investments are not protected.

2. AMT Exemptions

In 2007 congress increased the AMT exemptions to prevent millions of middle income taxpayers from being hit with the tax. The new exemptions are $44,350 for single taxpayers and heads of households, $33,125 for married filing separately, and $66,250 for married filing jointly. However, this exemption is only for the 2007 tax year and these numbers will drop in 2008 unless congress passes another AMT patch.

3. Higher Income IRA Limits

You can now take a full IRA deduction if your modified AGI (adjusted gross income) is less than $52,00 if you are single or the head of household or $83,00 if you are married filing jointly.

4. Higher 401(k) Limits

In 2007 there was a $500 increase on the limit for employee 401(k) contributions. The limit is now $15,500 for workers under 50, and $20,500 for workers over fifty. The increase also applies to other similar workplace retirement plans including 403(b)s and the federal Thrift Savings Plan.

5. Tax Free Employee Parking

Employer paid parking will no longer be considered as additional income for employees. However, this rule only applies to parking fees up to $215 per month, any additional money paid by the employer will still be considered income.

6. Inflation Indexed Brackets

Due to a high inflation rate in 2007, the 15, 25, 28, 33, and 35 percent tax brackets have all been raised by about 4%.

7. Higher Personal Exemptions

For the 2007 tax year the personal exemption amount was raised by $100 to $3,400.

8. Higher Standard Deductions

In 2007 the standard deductions for taxpayers also increased. You can now deduct $5,350 if you are a single taxpayer, $7,850 if the head of a household, and $10,700 if you are married filing jointly.

9. Reduction of Itemized Deduction Income Limits

The gradual reduction of itemized deductions and exemptions will now begin when a taxpayer’s AGI exceeds $156,400, no matter their filing status. The deductions are reduced by 2% of the amount a taxpayer’s income exceeds the limit. However, the reduction amount cannot exceed 80% of a taxpayer’s itemized deductions.

10. Higher Section 179 Deductions

For 2007 the limit on Section 179 deductions was raised by $17,000 to $125,000. Additionally, the annual investment limit was raised to $500,000.

11. Increased Income Limits for Hope and Lifetime Learning Credits

The amount of a taxpayer’s hope or lifetime learning credit is now gradually reduced if their modified AGI is $47,000 to $57,000 for single taxpayers and $94,000 to $114,000 for married filing jointly. However, taxpayers cannot claim an education credit if their modified AGI is above $57,000 for single taxpayers and $114,000 for married filing jointly.

12. Income from Abroad

The maximum foreign income exclusion was raised from $82,400 in 2006 to $85,700 for the 2007 tax year.

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