The maximum contribution per beneficiary was $2,000 in 2015.
The contribution is phased out for couples with modified adjusted gross income in excess of $190,000 and completely eliminated for singles with modified adjusted gross income in excess of $110,000).
Contributions to these accounts are nondeductible, but earnings accumulate tax-free, and withdrawals to pay college expenses of the child for whom the account exists are tax-exempt.
The tax-free withdrawals can be used for elementary and secondary education expenses.
Contributions to an Education Savings Account are separate from contributions to an individual's IRA.
Each state sets contribution frequencies and limits.
If used for qualified college expenses, growth inside the Section 529 Plan is tax-free.
The account owner can choose from several investment allocations offered by most plan sponsors.
Even after making a contribution to the Section 529 Plan, individuals can still make contributions to a Coverdell ESA.
Capital gains are not taxed until they are actually realized.
The capital gains are not taxed.
If you received $100 in interest from a bond in the current year, it would be taxed at your assumed 25% rate, leaving you $75 of after-tax income.
If the price of a stock increases by $100 during the current year, no tax is due until the stock is actually sold.
If you have capital gains, you can defer the taxes until the profit is realized, which could be years away.
If the market price of the stock is stable or increasing, earning capital gains can be achieved.
Investments that provide a tax-deferred build up of value may be more attractive than those that provide annual income.
The methods for trading current income for capital gains are described below.
Capital gains income can be earned by choosing growth over income stocks or mutual funds.
Companies and funds that pay out a low percentage of earnings as dividends are more likely to use the retained earnings to grow.
In the 1990s, index funds were very effective in this regard.
Capital gains were nearly equivalent to the rate of return on the market portfolio of stocks, as they earned market returns and paid out very low dividends.
If you are in the 15% capital gains tax brackets, your after-tax return will be 8.5% if you choose a company that pays dividends of 10% or more.
In comparison, a company or fund that pays no dividends but is expected to experience a 10% annual growth in its share price from reinvestment of earnings also offers an after-tax rate of return of 8.5%, but in this case the taxes will not have to be paid until the stock or fund At that point, the hope is that you will have a lower tax rate.
You've been able to keep invested the funds that you otherwise would have paid out in taxes if neither is the case.
As long as the stock price continues to increase, the deferral of tax payments is appealing.
A capital gains opportunity is also offered by one that is selling at a price far below its $1,000 par value.
Suppose you have the choice of buying ABC's bond, which has a coupon rate of 5% and is selling for $700 in the market, or DEF's bond, which has a coupon of 10% and is selling at par.
You will earn interest of $50 a year on the ABC bond.
At the end of 10 years, you will have a $300 capital gain, which will be taxed at a lower capital gains tax rate.
All of your return is ordinary income with the DEF bond.
The ABC bond is the better of the two because the capital gain is not taxed until it is realized at maturity.
Remember, though, that the higher-coupon bond is giving you a higher return earlier, and that adds to its attractiveness.
The rate-of-return analysis can be used to choose between the two bonds.
If you have $7,000 to invest, you could purchase 10 ABC bonds or 7 DEF bonds.
The ABC bonds have an annual interest of $500, while the DEF bonds have an annual interest of $700.
The DEF bonds have an after-tax advantage of $150 a year if you are in the 25% tax brackets.
The ABC bonds will be worth $10,000 at maturity, whereas the DEF bonds will only be worth $7,000.
The after-tax value of the addi tional $3,000 is $2,550, assuming a 15% capital gains tax rate.
The choice is between an additional $150 of income each year for the next 10 years or an additional $2,550 over the course of 10 years.
It would take an 11.3% rate of return to make you indifferent between the two bonds, using the future value techniques developed in Chapter 4, Appendix 4A.
If you invest $150 a year for 10 years at 11.3%, it will accumulate to $2,550 at the end of 10 years.
If you can invest at an after-tax rate greater than 11.3%, you should choose the DEF bonds, while if you feel your after tax reinvestment rate will be lower, you should choose the ABC bonds.
Federal tax law allows the depreciation of income property.
Ordinary pretax income can be deducted from a specified amount of annual depreciation.
When a property is sold, any amount received in excess of its original cost basis is treated as a capital gain and is taxed at the applicable capital gains rate.
The 25% recaptured depreciation tax rate is the difference between the original cost basis and the property's book value.
A taxpayer in the 15% marginal income tax brackets should not try to use depreciation as a tax-reduction strategy if it will result in a 25% tax.
Taxpayers in the 25% or higher tax brackets can benefit from the use of depreciation.
If you buy a 4-unit apartment building for $300,000 and hold it for 3 years, you will take $10,909 in depreciation each year.
At the end of the third year, you can sell it for its original price.
The depreciation you took reduced ordinary income by $10,909 and was worth if you had a 25% tax rate.
Your gain on the sale is calculated as 3 years, $10,909 per year, which results in a tax of $8,182.
You received a tax deferral because you didn't have to pay back the tax savings until the property was sold at the end of the third year.
The people in the higher tax brackets would get a tax advantage.
The use of the depreciation deduction results in a type of interest-free loan.
The primary tax benefit provided by depreciation is a tax deferral.
In our example, the tax deferrals of $2,727 in each of the first 3 years represent loans at a zero rate of interest that are repaid at the end of the third year.
Limits on the use of tax losses resulting from real estate invest ments, established by the Tax Reform Act of 1986, may limit an investor's ability to take advantage of depreciation tax benefits.
The ability to earn a profit from annual rents and/or appreciation has changed the appeal of real estate investment.
We have considered several short-term strategies to affect an inves tor's tax liability, including ways to exclude income from taxation, ways to defer taxes from one tax year to the next, and techniques that trade.
We will look at a strategy that reduces or eliminates a tax liability.
The tax swap is very popular among knowledgeable stock and bond investors at the end of the year.
Because the aim is to offset a gain, the securities that are sold in the tax swap should have lost money for the investor.
Although your tax liability has been reduced, your stock or bond position remains essentially unchanged because you are selling one security that has experienced a capital loss and replacing it with another similar security.
If you realized a capital gain on the sale of bonds in the current year, you could swap your taxes.
Assume that in your portfolio you held 100 shares of International Oil Corporation common stock, purchased 20 months earlier for $38 per share and currently selling for $28 per share.
It doesn't matter to you whether you hold International Oil or one of the other multinational oils, as long as you keep an oil stock in your portfolio.
You can realize the capital loss of $10 per share on International Oil by selling 100 shares and buying 100 shares of World Petroleum, which is also selling for $28 per share.
The result is a realized capital loss of $1,000, which can be used to offset the capital gain realized on the earlier bond sale.
The tax swap strategy may lose some of its appeal if capital gains tax rates are lower than ordinary income tax rates.
The capital gains tax rate that you face is 15% if you are in the 25% income tax brackets.
If the taxpayer is in the 25% tax brackets, it may be better to pay the capital gains tax equal to 15% of $1,100 or $165 and wait to apply the $1,000 loss against ordinary income the next year.
Year-end tax planning involves swaps of common stock.
Bond swaps are more popular because it is easier to find a substitute bond for the one held.
The recommended swaps for both stocks and bonds are published by most full-service brokerage houses.
It wouldn't make sense to sell the security for tax purposes and then immediately buy it back.
The tax deduction on the sale of a security can't be regained until 30 days after it's been sold.
Refer to the forms of income excluded from taxation.
Give a brief description of each of the programs for deferring taxes to retirement.
The following strategies trade current income for capital gains income.
For extended periods of time, effective tax strategy seeks to defer taxable income.
During the period of deferment, the earnings on investment can be reinvested.
The earnings from investment of pretax dollars over a long period of time can be large.
It is important to understand deferred annuities thoroughly.
The purchaser will receive a series of payments after paying a certain amount.
Hundreds of insurance companies issue annuities.
Because no payment is made to the purchaser, there is no tax liability created.
When received, earnings on the annuity become taxable.
The amount of the payment is based on statistical analyses performed by the insurance company and depends on the annuitant's gender and age; the payment is a function of how long the insurance company expects the annuitant to live.
The annuitant's option can be used to specify the date in the contract.
The annuitant's con tributions, interest earned on them, the annuitant's gender, and the annuitant's age are some of the factors that affect the amount of periodically received money.