The inaction and gridlock in the US Congress will again cause problems for the Internal Revenue Service with respect to the 2007 US Federal tax filing season. There are a number of tax relief bills that have not been passed, but that are likely to be passed by year end, that will affect 2007 Federal individual income tax returns.

The problem is that the Internal Revenue Service needs 10 weeks to reprogramme its computers for new tax law changes. Also, at this late date, all 2007 tax forms have been finalised and the Internal Revenue Service can not change the forms to comply with any new tax laws. Among the potential tax law changes are the following.

Alternative Minimum Tax

To keep hundreds of thousands of additional taxpayers from being subject to the Alternative Minimum Tax the exemptions are expected to increase to $66,250 for married filing joint returns and to $44,350 for single individuals.

Mortgage Relief

As we reported in an earlier column, if an individual loses their home to a bank because they cannot make payments on their mortgage, the outstanding balance on the mortgage that is forgiven by the bank is considered taxable income to the individual.

A bill is in process that will exempt the first $2 million of forgiven indebtedness from taxable income if the mortgage was on the individual's primary residence.

However, if these individuals own a second home at the time of the mortgage forgiveness, tax breaks associated with the future sale of the second home could be lost. Specific details will not be available until the bill is finalised.

2008 Tax Changes

l The Social Security wage base will increase to $102,000 in 2008. Thus, the maximum social security tax in 2008 will be 6.2 percent of $102,000 or $6,324, an increase of $279 from 2007.

l Medicare tax will continue to be 1.45 percent of an individual's entire compensation.

l In 2008 the contribution limit to an IRA will increase to $5,000 and anyone born before 1959 can contribute an additional $1,000.

l The maximum contribution to a 401(k) in 2008 will remain the same as in 2007, $15,500 and anyone born before 1959 can contribute an additional $5,000.

2007/2008 Tax Planning

Traditional tax planning calls for deferring income and accelerating deductions. The problem with both approaches is that it ignores the current and the future consequences of doing so. Accelerating deductions is a good idea, but if you are accelerating the payment of state income taxes and real estate taxes you could be exposing yourself to the Alternative Minimum Tax, which would negate any income tax benefit received from the accelerated deductions. What you should do before accelerating the deductions is to compute your tax liability under both the regular income tax and the alternative minimum tax using both scenarios.

Deferring income such as year-end bonuses is a tried and true idea, but one has to keep an eye on what the future holds. The Democrats have introduced a tax bill, with no chance of passage in 2007 that will impose a surcharge of four percent on married filing joint tax returns with an adjusted gross income of $250,000 and 4.6 percent on married filing joint tax returns with an adjusted gross income of $500,000. Coupled with a proposed five percent reduction in itemised deductions for these same taxpayers, the overall effect would be closer to a 10 percent increase in tax.

If there is a Democratic President and Congress in 2009, the above tax bill could become a reality. Thus, 2008 could be a year in which individuals may look to increase income, rather than to defer it.

Gifts of Appreciated Stock

Consider giving gifts of appreciated stock in 2007. If you have owned the shares for over a year you can get a deduction for the full fair market value of the stock and avoid paying taxes on the gain. For example, let's say that you bought stock at $25,000 that you have held for over a year that is now worth $85,000. If you sell the stock you would have to pay a long-term capital gains tax of $9,000 ($85,000 les $25,000 = $60,000 gain times 15 percent tax).

This would leave a $76,000 gift to charity ($85,000 less $9,000 tax). Your tax benefit would likely be $26,600 ($76,000 times 35 percent). By gifting the stock to charity your tax benefit is $29,750 ($85,000 times 35 percent). So your gift is $9,000 more and you tax savings increases by $3,150.

The tax advice given by this column is, by necessity, general in nature. You should, of course, check with your own US tax consultant as to how specific transactions affect you since tax advice varies with individual circumstances.

James Paul Sabo, CPA, is the President of ETS Ltd., PO Box HM 1574, Hamilton HM GX, Bermuda. Questions should be sent to: jsabo[AT]expatriatetaxservices.com