2011 Tax Planning Strategies

Year-end tax planning is especially challenging this year because of uncertainty over whether Congress will enact sweeping tax reform that could have a major impact in 2012 and beyond. And even if there’s no major tax legislation in the immediate future, Congress next year still will have to grapple with a host of thorny issues, such as whether to once again “patch” the alternative minimum tax (e.g., to avoid a drastic drop in post-2011 exemption amounts), and what to do about the post-2012 expiration of the Bush-era income tax cuts (including the current rate schedules, and low tax rates for long-term capital gains and qualified dividends), and the expiration of favorable estate and gift rules for estates of decedents dying, gifts made, or generation-skipping transfers made after Dec. 31, 2012.

Regardless of what Congress does late this year or early the next, there are solid tax savings to be realized by taking advantage of tax breaks that are on the books for 2011 but may be gone next year unless they are extended by Congress. These include, for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line deduction for qualified higher education expenses; and tax-free distributions by those age 70 1/2 or older from IRAs for charitable purposes. For businesses, tax breaks that are available through the end of this year but won’t be around next year unless Congress acts include: 100% bonus first year depreciation for most new machinery, equipment and software; an extraordinarily high $500,000 expensing limitation (and within that dollar limit, $250,000 of expensing for qualified real property); and the research tax credit.

We have compiled a checklist of actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you will likely benefit from many of them. We can narrow down the specific actions that you can take once we meet with you to tailor a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make:

Year-End Tax Planning Moves for Individuals

•Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year. Don’t forget that you can no longer set aside amounts to get tax-free reimbursements for over-the-counter drugs, such as aspirin and antacids.

•If you become eligible to make health savings account (HSA) contributions in December of this year, you can make a full year’s worth of deductible HSA contributions for 2011.

•Realize losses on stock while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later. It may be advisable for us to meet to discuss year-end trades you should consider making.

•Postpone income until 2012 and accelerate deductions into 2011 to lower your 2011 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2011 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, the above-the-line deduction for higher-education expenses, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2011. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year.

•If you believe a Roth IRA is better than a traditional IRA, and want to remain in the market for the long term, consider converting traditional-IRA money invested in beaten-down stocks (or mutual funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2011.

• If you converted assets in a traditional IRA to a Roth IRA earlier in the year, the assets in the Roth IRA account may have declined in value, and if you leave things as-is, you will wind up paying a higher tax than is necessary. You can back out of the transaction by recharacterizing the rollover or conversion, that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later reconvert to a Roth IRA.

•It may be advantageous to try to arrange with your employer to defer a bonus that may be coming your way until 2012.

•Consider using a credit card to prepay expenses that can generate deductions for this year.

•If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2011 if doing so won’t create an alternative minimum tax (AMT) problem.

•Take an eligible rollover distribution from a qualified retirement plan before the end of 2011 if you are facing a penalty for underpayment of estimated tax and the increased withholding option is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2011. You can then timely roll over the gross amount of the distribution, as increased by the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2011, but the withheld tax will be applied pro rata over the full 2011 tax year to reduce previous underpayments of estimated tax.

•Estimate the effect of any year-end planning moves on the alternative minimum tax (AMT) for 2011, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes (or state sales tax if you elect this deduction option), miscellaneous itemized deductions, and personal exemption deductions. Other deductions, such as for medical expenses, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. As a result, in some cases, deductions should not be accelerated.

•Accelerate big ticket purchases into 2011 in order to assure a deduction for sales taxes on the purchases if you will elect to claim a state and local general sales tax deduction instead of a state and local income tax deduction. Unless Congress acts, this election won’t be available after 2011.

•You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions.

•If you are a homeowner, make energy saving improvements to the residence, such as putting in extra insulation or installing energy saving windows, or an energy efficient heater or air conditioner. You may qualify for a tax credit if the assets are installed in your home before 2012.

•Unless Congress extends it, the up-to-$4,000 above-the-line deduction for qualified higher education expenses will not be available after 2011. Thus, consider prepaying eligible expenses if doing so will increase your deduction for qualified higher education expenses. Generally, the deduction is allowed for qualified education expenses paid in 2011 in connection with enrollment at an institution of higher education during 2011 or for an academic period beginning in 2011 or in the first 3 months of 2012.

•You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year.

•You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.

Purchase qualified small business stock (QSBS) before the end of this year. There is no tax on gain from the sale of such stock if it is (1) purchased after September 27, 2010 and before January 1, 2012, and (2) held for more than five years. In addition, such sales won’t cause AMT preference problems. To qualify for these breaks, the stock must be issued by a regular (C) corporation with total gross assets of $50 million or less, and a number of other technical requirements must be met. Our office can fill you in on the details.

•If you are age 70-1/2 or older, own IRAs and are thinking of making a charitable gift, consider arranging for the gift to be made directly by the IRA trustee. Such a transfer, if made before year-end, can achieve important tax savings.

• Take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retired plan) if you have reached age 70-1/2. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70-1/2 in 2011, you can delay the first required distribution to 2012, but if you do, you will have to take a double distribution in 2012—the amount required for 2011 plus the amount required for 2012. Think twice before delaying 2011 distributions to 2012—bunching income into 2012 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2012 if you will be in a substantially lower bracket that year, for example, because you plan to retire late this year.

• Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. You can give $13,000 in 2011 to each of an unlimited number of individuals but you can’t carry over unused exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets who are not subject to the kiddie tax.

Year-End Tax-Planning Moves for Businesses & Business Owners

•Businesses should consider making expenditures that qualify for the business property expensing option. For tax years beginning in 2011, the expensing limit is $500,000 and the investment ceiling limit is $2,000,000. And a limited amount of expensing may be claimed for qualified real property. However, unless Congress changes the rules, for tax years beginning in 2012, the dollar limit will drop to $139,000, the beginning-of-phaseout amount will drop to $560,000, and expensing won’t be available for qualified real property. The generous dollar ceilings that apply this year mean that many small and medium sized businesses that make timely purchases will be able to currently deduct most if not all their outlays for machinery and equipment. What’s more, the expensing deduction is not prorated for the time that the asset is in service during the year. This opens up significant year-end planning opportunities.

•Businesses also should consider making expenditures that qualify for 100% bonus first year depreciation if bought and placed in service this year. This 100% first-year writeoff generally won’t be available next year unless Congress acts to extend it. Thus, enterprises planning to purchase new depreciable property this year or the next should try to accelerate their buying plans, if doing so makes sound business sense.

•Nail down a work opportunity tax credit (WOTC) by hiring qualifying workers (such as certain veterans) before the end of 2011. Under current law, the WOTC won’t be available for workers hired after this year.

•Make qualified research expenses before the end of 2011 to claim a research credit, which won’t be available for post-2011 expenditures unless Congress extends the credit.

•If you are self-employed and haven’t done so yet, set up a self-employed retirement plan.

•Depending on your particular situation, you may also want to consider deferring a debt-cancellation event until 2012, and disposing of a passive activity to allow you to deduct suspended losses.

•If you own an interest in a partnership or S corporation you may need to increase your basis in the entity so you can deduct a loss from it for this year.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you.

By Don James CPA/PFS, CFP

Fate of Bush-era tax cuts derails super committee

Congress’ Joint Select Committee on Deficit Reduction (the so-called “super committee”) failed to reach an agreement by its November 23 deadline after weeks of sparring over the Bush-era tax cuts.  The Budget Control Act of 2011 created the bipartisan super committee in August and instructed it to develop proposals to reduce the federal budget deficit by November 23.  The super committee held many meetings and reportedly debated several proposals, all behind closed doors, to reform the Tax Code and entitlement programs. In the end, however, Democrats and the GOP remained far apart on taxes and entitlement programs and announced they could not agree on a final proposal.

Bush-era tax cuts

One tax item in particular appeared to frustrate the progress of the super committee:  the fate of the Bush-era tax cuts.  Last year, the White House and Congress agreed to extend the Bush-era tax cuts through 2012. Under current law, the following Bush-era tax cuts (not an exhaustive list) will expire after 2012 unless extended:

• Reduced individual income tax rates (10, 15, 28, 33, and 35 percent)
• Reduced capital gains and dividends tax rates
• Marriage penalty relief (expanded 15 percent tax bracket for joint filers and standard deduction for married couples twice that of single individuals)
• Repeal of the limitation on itemized deductions for higher income taxpayers
• Repeal of the phase out of personal exemptions for higher income taxpayers

In September, President Obama sent the super committee a plan that would have extended the Bush-era tax cuts for lower and moderate income individuals but not for higher income taxpayers (which the White House defines as single individuals with incomes over $200,000 and married couples with incomes over $250,000).   The House GOP presented a plan that would have lowered the maximum individual and corporate tax rates to 25 percent.  Several committees and individual lawmakers also sent deficit reduction plans to the super committee.

In the days leading up to the November deadline, Democratic and Republican members of the super committee acknowledged that they had reached little common ground over the fate of the Bush-era tax cuts. On November 21, the co-chairs of the super committee announced that that they “[had] come to the conclusion that it will not be possible to make any bipartisan agreement available to the public before the committee’s deadline.”

With the super committee sidelined, the fate of the Bush-era tax cuts moves to Congress and the White House.  The GOP-controlled House could try to extend the Bush-era tax cuts in stand-alone legislation but any bill would likely fail to pass the Senate. Additionally, President Obama has repeatedly said he will veto legislation that extends the Bush-era tax cuts for higher income taxpayers.

Payroll tax cut

More immediately, the White House and Congress are currently debating the fate of extending for another year the 2011 payroll tax cut. Wage earners and self-employed individuals took home more pay in 2011 because of a temporary reduction in the employee-share of old age, survivors and disability (OASDI) taxes.  The employee-share of OASDI taxes was reduced from 6.2 percent to 4.2 percent for calendar year 2011 (with similar relief provided to self-employed individuals). ). Although both sides of the aisle in Congress agree that an extension through 2012 is desirable, consensus must be achieved in agreeing to ways to pay for its $263 billion price tag.  An agreement is expected sometime in December, although prospects are not entirely certain.

Budget cuts

The super committee’s failure to deliver a deficit reduction plan automatically triggers spending cuts after 2012. Under the Budget Control Act, the spending reductions will be achieved through a combination of sequestration (for FY 2013) and the downward adjustment of discretionary spending limits for FY 2014-FY 2021. This means that Congress must determine the manner in which reductions are made to the federal government’s budget, including the IRS, through the annual appropriations process each year.  However, some programs, such as Social Security and Medicaid, are exempt from the budget cuts.

President Obama and Congress could agree to modify the spending reductions under the Budget Control Act.  On November 21, President Obama said he will veto any bills that remove the automatic triggers in the Budget Control Act. President Obama is reportedly using the veto threat to keep pressure on Congress to reach an agreement over the fate of the Bush-era tax cuts and entitlement spending.

By Don James CPA/PFS, CFP

IRS’s “common law” test to determine independent contractor/employee status

It’s critical for an enterprise periodically to review the status of its workers and see if they are properly classified. An enterprise must withhold federal income tax, social security taxes, and federal unemployment taxes on wages it pays workers who are employees. It also may have to provide them with the same fringe benefits and retirement plan coverage available to its other employees. There may be state tax obligations as well. By contrast, these responsibilities don’t apply for workers who are independent contractors. The business simply cuts them a check for their services and sends them a Form 1099-MISC.

Under the “common law” rules developed by the courts, a worker generally is an employee for federal tax purposes if the employer has the right to control and direct the worker regarding the job he is to do and how he is to do it. The employer doesn’t have to actually direct or control how the services are performed; it’s enough if the employer has the right to do so. IRS usually applies the following factors to see if the employer has the right to direct and control the worker:

• A worker who must comply with instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the business has the right to make the worker follow instructions. However, instructions regarding government standards are given little weight, as is the absence of instructions for professionals such as attorneys, who must follow the rules of their profession.
• Training a worker by teaming an experienced employee with the worker, by corresponding with the worker, by requiring him or her to attend meetings, or by using other methods, indicates the business wants the services performed in a particular method or manner. Ongoing training is a particularly strong sign of an employer-employee relationship, but orientation or information programs about company policies aren’t.
• Integration of the worker’s services into the business operations generally shows the worker is subject to direction and control.
• If the services must be rendered personally, the business probably is interested in the methods used to accomplish the work as well as in the results.
• A business that hires, supervises, and pays assistants for a worker is exhibiting employer-like control over the worker on the job. Conversely, an independent contractor relationship is indicated if a worker is contractually obligated to hire, supervise, and pay assistants.
• A continuing relationship between the worker and the business indicates an employer-employee relationship exists. A continuing relationship may exist where the worker is called in at frequently recurring, although irregular, intervals.
• The fact that a business requires work to be performed on its premises suggests control over the worker (if the work could be done elsewhere). Work done off the premises, such as at the worker’s office, indicates some freedom from control. The importance of this factor depends on the type of services involved and whether an employer generally would require employees to do similar work on its premises.
• A business exhibits control over a worker if it requires him or her to perform services in a specific order or sequence.
• A business’s requirement that the worker submit regular or written reports indicates a degree of control over the worker.
• Payment by the hour, week, or month generally points to an employer-employee relationship, if this method of payment isn’t just a convenient way of paying a lump-sum agreed upon as the cost of a job. Payment by the job or on a straight commission basis generally indicates a worker is an independent contractor.
• A business exhibits characteristics of an employer if it supplies a worker with significant tools, materials, and other equipment, or ordinarily pays the worker’s business and/or traveling expenses.
• A worker exhibits independent contractor status if he or she invests in facilities that aren’t typically maintained by employees (e.g., renting his or her own office). By contrast, an employee usually relies on the employer to provide the facilities needed to do the job.
• A worker who can realize a profit or suffer a loss as a result of his or her services generally is an independent contractor, but a worker who can’t is an employee. The risk that a worker won’t be paid isn’t factored in.
• A worker who performs more than minimal services for a number of unrelated businesses at the same time generally is an independent contractor. However, a person who works for more than one business may be an employee of each business, especially where the businesses are part of the same service arrangement.
• The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship.
• The right to fire a worker is a factor indicating that he or she is an employee. An independent contractor on the other hand, can’t be fired as long as he or she produces the work that was contracted-for.

There is no litmus test for exactly how many of these factors must be satisfied, nor are these factors uniformly applied. Please call our offices (440-238-0222) if you would like to arrange for an appointment to see whether your workers are classified properly.

Health savings accounts

Given the ever-escalating cost of providing employee health care benefits, I am blogging to advise you of a more cost-effective method of providing these benefits; namely, a health savings account (HSA). For eligible individuals, HSAs offer a tax-favorable way to set aside funds (or have their employer do so) to meet future medical needs. Here are the key tax-related elements:

• contributions you make to an HSA are deductible, with limits,
• contributions your employer makes aren’t taxed to you,
• earnings on the funds within the HSA are not taxed, and
• distributions from the HSA to cover qualified medical expenses are not taxed.

Who is eligible? To be eligible for an HSA, you must be covered by a “high deductible health plan” (discussed below). You must also not be covered by a plan which (1) is not a high deductible health plan, and (2) provides coverage for any benefit covered by your high deductible plan. (It’s okay, however, to be covered by a high deductible plan along with separate coverage, through insurance or otherwise, for accidents, disability, or dental, vision, or long-term care.)

For 2010, a “high deductible health plan” is a plan with an annual deductible of at least $1,200 for self-only coverage, or at least $2,400 for family coverage. For self-only coverage, the 2010 limit on deductible contributions is $3,050. For family coverage, the 2010 limit on deductible contributions is $6,150. Additionally, annual out-of-pocket expenses required to be paid (other than for premiums) for covered benefits cannot exceed $5,950 for self-only coverage or $11,900 for family coverage.

An individual (and the individual’s covered spouse as well) who has reached age 55 before the close of the tax year (and is an eligible HSA contributor) may make additional “catch-up” contributions for 2010 of up to $1,000.

A high deductible health plan does not include a plan if substantially all of the plan’s coverage is for accidents, disability, or dental, vision, or long-term care, insurance for a specified disease or illness, or insurance paying a fixed amount per day (or other period) of hospitalization.

HSAs may be established by, or on behalf of, any eligible individual.

Deduction limits. You can deduct contributions to an HSA for the year up to the total of your monthly limitations for the months you were eligible. For 2010, the monthly limitation on deductible contributions for a person with self-only coverage is 1/12 of $3,050. For an individual with family coverage, the monthly limitation on deductible contributions is 1/12 of $6,150. Thus, deductible contributions are not limited by the amount of the annual deductible under the high deductible health plan.

Also, taxpayers who are eligible individuals during the last month of the tax year are treated as having been eligible individuals for the entire year for purposes of computing the annual HSA contribution.

However, if an individual is enrolled in Medicare, he is no longer an eligible individual under the HSA rules, and so contributions to his HSA can no longer be made.

Contributions may be made to an HSA by or on behalf of an eligible individual even if the individual has no compensation, or if the contributions exceed the individual’s compensation. Contributions made by a family member on behalf of an eligible individual to an HSA (which are subject to the limits described above) are deductible by the eligible individual in computing adjusted gross income.

Rollovers from IRAs, FSAs, and HRAs. For a limited period (beginning Dec. 20, 2006, and ending December 31, 2011) an eligible individual can make a one-time transfer of amounts from a health flexible spending arrangement (health FSA) or health reimbursement arrangement (HRA) to an HSA. The amount transferred is limited to the lesser of (i) the account balance of the individual’s health FSA or HRA as of September 21, 2006, or (ii) the account balance of the health FSA or HRA on the transfer date.

Similarly, on a once-only basis, taxpayers can withdraw funds from an IRA, and transfer them tax-free to an HSA. The amount transferred can be up to the maximum deductible HSA contribution for the type of coverage (individual or family) in effect at the time of the transfer. The amount so transferred is excluded from the taxpayer’s gross income, and is not subject to the 10% early withdrawal penalty.

Employer contributions. If you are an eligible individual, and your employer contributes to your HSA, the employer’s contribution is treated as employer-provided coverage for medical expenses under an accident or health plan and is excludable from your gross income up to the deduction limitation, as described above. Further, the employer contributions are not subject to withholding from wages for income tax or subject to FICA or FUTA. The eligible individual cannot deduct employer contributions on his federal income tax return as HSA contributions or as medical expense deductions.

An employer that decides to make contributions on its employees’ behalf must make comparable contributions to the HSAs of all comparable participating employees for that calendar year. If the employer does not make comparable contributions, the employer is subject to a 35% tax on the aggregate amount contributed by the employer to HSAs for that period.

Contributions are comparable if they are either: (1) the same amount; or (2) the same percentage of the annual deductible limit under the high deductible health plan covering the employees. For these purposes, comparable participating employees (1) are covered by the employer’s high deductible health plan and are eligible to establish an HSA; (2) have the same category of coverage (either self-only or family coverage); and (3) have the same category of employment (either part-time or full-time). (IRS regs provide detailed guidelines for comparable contributions.)

An exception to the comparable contribution requirements applies for contributions made on behalf of nonhighly compensated employees. Under this exception, an employer may make larger HSA contributions for nonhighly compensated employees than for highly compensated employees.

Employer contributions are also excludable if made at the election of the employee under a salary reduction arrangement that is part of a cafeteria plan (i.e., a plan which allows you to elect to use part of your salary towards a variety of benefits). Although contributions to an employee’s HSA through a cafeteria plan are treated as employer contributions, the comparability rule does not apply to contributions made through a cafeteria plan.

Earnings. If the HSA is set up properly, it is generally exempt from taxation, and there is no tax on earnings. However, taxes may apply if contribution limitations are exceeded, required reports are not provided, or prohibited transactions occur.

Distributions. Distributions from the HSA to cover an eligible individual’s qualified medical expenses, or those of his spouse or dependents, are not taxed. Qualified medical expenses for these purposes generally mean those that would qualify for the medical expense itemized deduction. If funds are withdrawn from the HSA for other reasons, the withdrawal is taxable. Additionally, an extra 10% tax will apply to the withdrawal, unless it is made after reaching age 65, or in the event of death or disability.

Distributions from an HSA exclusively to pay for qualified medical expenses are excludable from the gross income of the account beneficiary even though the beneficiary is no longer an “eligible individual,” e.g., the individual is over age 65 and entitled to Medicare benefits, or no longer has a high deductible health plan.

As you can see, HSAs offer a very flexible option for providing health care coverage, but the rules are somewhat involved.

Tax treatment of scholarships

Scholarships (and fellowships) are generally tax-free, whether for elementary or high school students, for college or graduate students, or for students at accredited vocational schools. It makes no difference whether the scholarship takes the form of a direct payment to the individual or a tuition reduction.

However, for the scholarship to be tax-free, certain conditions must be satisfied. The most important are that the award must be used for tuition and related expenses (and not for room and board) and that it must not be compensation for services.

Tuition and related expenses. A scholarship is tax-free only to the extent it is used to pay for (1) tuition and fees required to attend the school or (2) fees, books, supplies, and equipment required of all students in a particular course. For example, if a computer is recommended but not required, buying one wouldn’t qualify. Other expenses that don’t qualify include the cost of room and board, travel, research, and clerical help.

To the extent a scholarship award isn’t used for qualifying items, it is taxable. The recipient is responsible for establishing how much of the award was used for qualified tuition and related expenses so as to be tax-free. You should maintain records (e.g., copies of bills, receipts, cancelled checks) that reflect the use of the scholarship money.

Scholarship award can’t be payment for services. A scholarship isn’t tax-free if the payments are linked to services that your child performs as a condition for receiving the award, even if those services are required of all degree candidates. Thus, a stipend your child receives for required teaching, research, or other services is taxable, even if the child uses the money for tuition or related expenses.

Returns and records. If the scholarship is tax-free and your child has no other income, the award doesn’t have to be reported on a return. However, any portion of the award that is taxable as payment for services is treated as wages, and the payor should withhold accordingly. Estimated tax payments may have to be made if the payor doesn’t withhold enough tax. Your child should receive a Form W-2 showing the amount of these “wages” and the amount of tax withheld, but any portion of the award that is taxable must be reported, even if no Form W-2 is received.

Your child’s award can have the following impact on these related tax issues:

(1) The dependency exemption that you claim for your child shouldn’t be threatened by the scholarship. To claim an individual as your dependent, you must meet a support test. Although education is a support item, a special rule provides that educational costs covered by a scholarship (or fellowship) for a dependent who is a child of the taxpayer (but not for other dependents) aren’t included in the calculation of total support.

(2) Any taxable scholarship amounts should increase your child’s standard deduction. As noted above, to the extent scholarship funds are spent on room, board, or other nonqualifying expenses, the award is taxable. However, it is treated as “earned income.” This means if the student is being claimed as a dependent by his parent, and using the standard deduction he or she may qualify for a higher standard deduction.

The standard deduction allowed to dependents is the greater of: (a) $950 for 2009 ($900 for 2008) or (b) $300 (for 2008 and 2009) plus the dependent’s earned income. But the standard deduction can’t be more than the regular standard deduction ($5,700 for single taxpayers in 2009; $5,450 in 2008). So even though part of a scholarship is taxable, it may be “covered” by the standard deduction.

Example. Tim is a dependent of his parents. His only income is $3,000 he received as part of a scholarship, which is taxable because it was applied to cover his costs of room and board. Since the $3,000 is treated as earned income, Tim is entitled to a $3,300 standard deduction, which reduces his taxable income to zero.

(3) The tax-free scholarship may limit other higher education tax benefits you or your child may be entitled to. If your child receives a tax-free scholarship and his or her higher education expenses also qualify for any of the following credits, deductions, and exclusions, the expenses taken into account in computing any of these other benefits must first be reduced by the tax-free amounts used to pay the expenses:

American Opportunity tax credit (i.e., the Hope credit, as modified for 2009 and 2010) and Lifetime Learning credit.

Deduction for higher education expenses.

Deduction for interest on student loans

Coverdell ESA distribution exclusion.

Qualified tuition (529) plan distribution exclusion.

Savings bond interest exclusion.

In other words, neither you nor your child may claim a credit, deduction, or exclusion based on expenses paid with tax-free scholarship funds.  (However, a student can voluntarily allocate a portion of the scholarship money to room & board by filing a tax return and reporting it as income.  His parents then can claim a credit or deduction since the amount they paid would now be allocated to tuition and fees.)

Note that we help parents with a college-bound high school student, who won’t qualify for need-based financial aid, reduce their college expenses by thousands of dollars.  In many cases our customized planning results in a family knocking off a full year’s cost of college.  Please contact us for more information.

Post-2009 Roth IRA rollovers

As you have probably heard, in 2010, for the first time, you may roll over amounts in qualified employer-sponsored retirement plan accounts, such as 401(k)s and profit sharing plans, and regular IRAs, into Roth IRAs—regardless of your adjusted gross income (AGI).

What’s so attractive about a Roth IRA? Here’s a summary:

• Earnings within the account are tax-sheltered (as they are with a regular qualified employer plan or IRA).
• Unlike a regular qualified employer plan or IRA, withdrawals from a Roth IRA aren’t taxed if some relatively liberal conditions are satisfied.
• A Roth IRA owner does not have to commence lifetime required minimum distributions (RMDs) after he or she reaches age 70 1/2 as is generally the case with regular qualified employer plans or IRAs. (For 2009, there was a moratorium on RMDs.)
• Beneficiaries of Roth IRAs also enjoy tax-sheltered earnings (as with a regular qualified employer plan or IRA) and tax-free withdrawals (unlike with a regular qualified employer plan or IRA). They do, however, have to commence regular withdrawals from a Roth IRA after the account owner dies.

The catch, and it’s a big one, is that the rollover will be fully taxed, assuming the rollover is being made with pre-tax dollars (money that was deductible when contributed to an IRA, or money that wasn’t taxed to an employee when contributed to the qualified employer-sponsored retirement plan) and the earnings on those pre-tax dollars. For example, if you are in the 28% federal tax bracket and roll over $100,000 from a regular IRA funded entirely with deductible dollars to a Roth IRA, you’ll owe $28,000 of tax. So you’ll be paying tax now for the right to future tax-free withdrawals, and freedom from the RMD rules.

Should you consider making the rollover to a Roth IRA? The answer may be “yes” if:

• You can pay the tax on the rollover with non-retirement-plan funds. Keep in mind that if you use retirement plan funds to pay the tax on the rollover, you’ll have less money building up tax-free within the account.
• You anticipate paying taxes at a higher tax rate in the future than you are paying now. Many observers believe that tax rates for upper middle income and high income individuals will trend higher in future years. (See discussion below regarding Medicare tax on investment income beginning in 2013.)
• You have a number of years to go before you might have to tap into the Roth IRA. This will give you a chance to recoup (via tax-deferred earnings and tax-deferred payouts) the tax hit you absorb on the rollover.
• You are willing to pay a tax price now for the opportunity to pass on a source of tax-free income to your beneficiaries.

Roth rollovers made in 2010 represent a novel tax deferral opportunity and a novel choice. If you make a rollover to a Roth IRA in 2010, the tax that you’ll owe as a result of the rollover will be payable half in 2011 and half in 2012, unless you elect to pay the entire tax bill in 2010.

Why on earth would you choose to pay a tax bill in 2010 instead of deferring it to 2011 and 2012? Keep in mind that absent Congressional action, after 2010, the tax brackets above the 15% bracket will revert to their higher pre-2001 levels. That means the top four brackets will be 39.6%, 36%, 31%, and 28%, instead of the current top four brackets of 35%, 33%, 28%, and 25%.

What’s more, beginning in 2013, a Medicare tax will, for the first time, be applied to investment income. A new 3.8% tax will be imposed on net investment income of single taxpayers with AGI above $200,000 and joint filers over $250,000 (unindexed).

Net investment income is interest, dividends, royalties, rents, gross income from a trade or business involving passive activities, and net gain from disposition of property (other than property held in a trade or business). Net investment income is reduced by the deductions that are allocable to that income. Although the new tax won’t apply to income in tax-deferred retirement accounts such as 401(k) plans, taxable distributions from these plans can push your income over the limit subjecting your investment income to the higher rates.

Because the new tax on investment income won’t take effect for three years, that leaves more time for Congress and the IRS to tinker with it. So we can expect lots of refinements and “clarifications” between now and when the tax actually takes hold in 2013.

So if you believe there’s a strong chance your tax rates will go up after 2010, you may want to consider paying the tax on the Roth rollover in 2010.

Individuals ineligible to make deductible contributions to a traditional IRA, or to make any regular contributions to a Roth IRA, due to limitations based on adjusted gross income, may contribute to a traditional IRA and then convert this amount to a Roth IRA. So individuals who have never opened a traditional IRA because they weren’t able to make deductible contributions (and who have never rolled over pre-tax dollars to a regular IRA) should consider opening such an IRA and making the biggest allowable nondeductible contribution they can afford. If they convert the traditional IRA to a Roth IRA they will have to include in gross income only that part of the amount converted that is attributable to income earned after the IRA was opened, presumably a small amount. They could continue to make nondeductible contributions to a traditional IRA in later years, and roll the contributed amount over into a Roth IRA. However, note that if an individual previously made deductible IRA contributions, or rolled over qualified plan funds to an IRA, complex rules determine the taxable amount.

You need to consider your family’s entire financial situation before you plan for a large rollover to a Roth IRA. There also are many details that you should go over, such as whether the amounts you are thinking of switching to a Roth IRA are eligible for the rollover (technically, they are called “eligible rollover distributions”), whether you can make rollovers from your employer sponsored plan (for example, there are restrictions on rollovers from 401(k) plans), and the tax impact of rolling over amounts that represent nondeductible as well as deductible contributions. 

Finally, there are investment strategies you should consider such as setting up “segregated” Roth accounts where you put bonds, stocks and other assets in different Roth IRA accounts. Because you can’t recharacterize (undo) portions of a Roth IRA, if you are concerned about specific assets or asset classes losing value later, you can segregate those, at conversion, into several different accounts.  So if they did in fact lose value, you could recharacterize selected individual accounts.

Alternative minimum tax—Individuals

The tax law gives special treatment to certain kinds of income and allows special deductions for certain kinds of expenses. The AMT was designed to increase the tax bill of taxpayers who take undue advantage of these tax benefits to avoid significant tax liability.

The basic mechanism by which the AMT accomplishes its objective is by treating certain items less favorably than they are for purposes of the regular tax. These items are referred to as “tax preferences” or “adjustments.” Adjustments differ from preferences only in that adjustments involve a substitution of a special AMT treatment of an item for the regular tax treatment (for example, no deduction is allowed for personal and dependency exemptions), while a preference generally involves the addition of the difference between the special AMT treatment and the regular tax treatment (for example, depletion is limited to the adjusted basis of the property).

The AMT starts with your regular taxable income and, in general, makes you “give back” the tax preferences and adjustments until you arrive at “alternative minimum taxable income” (AMTI). Then, after subtracting an exemption amount (discussed below), a tax rate of 26% applies to the first $175,000 of this income and 28% to amounts above $175,000. (For married taxpayers who file separately, the rate changes at $87,500.) However, the AMT rates for long-term capital gains, as well as dividends that qualify to be taxed at long-term capital gain rates, are the same favorable rates that apply for regular tax purposes.

If the tax liability under the AMT system is higher than your regular tax liability, you must pay the higher amount. If the AMT liability comes out below your regular liability, then the AMT has no tax impact on you and you simply pay the regular tax.

You may be subjected to the AMT even if you have no tax preferences. For example, if you have a large family, elimination of the personal and dependency exemptions to which you are entitled for regular tax purposes may cause you to be subject to the AMT.

You compute the AMT on a special IRS form (Form 6251) that must be attached to your Form 1040.

Adjustments and preferences. The following are some of the more common adjustments or preferences required to arrive at AMTI:

(1) Tax-exempt interest. Tax-exempt interest from certain private activity bonds (other than qualifying bonds issued in 2009 or 2010) isn’t exempt for AMT purposes. Thus, although you exclude this interest from your regular taxable income, you must include it in AMTI.

(2) Interest deduction. For AMT purposes you can only deduct mortgage or home equity loan interest on funds you borrowed to buy, build, or substantially improve your home or a second residence (or on the refinancing of that debt). So, if you claimed a regular tax deduction for interest on a home equity loan that you didn’t devote to the home, you would have to add it back in determining AMTI. Also, an adjustment may have to be made to your investment interest deduction in some cases for AMT purposes.

(3) State and local tax deduction. For AMT purposes, you get no deduction for state and local income taxes, or real estate or other property taxes, although a deduction is allowed for regular tax purposes. So you will have to add any income or property taxes you deducted for regular tax purposes back to taxable income in determining AMTI. But you can deduct motor vehicle taxes (for new vehicles purchased after Feb. 16, 2009 and before 2010).

(4) Medical expenses. If you are deducting any medical expense for regular tax purposes, some of the deduction will be lost for AMT purposes. For regular tax purposes, medical expenses are deductible to the extent they exceed 7.5% of adjusted gross income (AGI). For AMT purposes, however, they are only deductible to the extent they exceed 10% of AGI. Thus, you would compute your reduced deduction amount and add the difference back to taxable income in determining AMTI. (For example, if your “regular” medical deduction was $8,000 and your AMT medical deduction is $6,000, you would add back $2,000 to taxable income.)

(5) Miscellaneous itemized deductions. If you are entitled to a regular tax deduction for any miscellaneous itemized expenses (these are deductions that are limited, even for regular tax purposes, to the excess over 2% of your AGI), you would not get any deduction for them for AMT purposes, regardless of what they are comprised of.

(6) Personal and dependency exemptions. These aren’t allowed. You must add them back to your regular taxable income in determining AMTI.

(7) Standard deduction. If you take the standard deduction instead of itemizing, you must add back the deduction (other than the disaster loss component or the motor vehicle tax component (for new vehicles purchased after Feb. 16, 2009 and before 2010)) to determine AMTI.

(8) Incentive stock options (ISOs). The favorable tax treatment allowed for ISOs isn’t allowed for AMT purposes. This means that although you don’t pay any regular tax when you exercise an ISO, you may have to pay AMT on the value of the stock you receive (minus what you paid for it) in the year you exercise the ISO unless you sell the stock that year. This is true even if the stock price declines significantly after you exercise the ISO.

(9) Depreciation deductions. For certain depreciable property, the depreciation schedules are slower for AMT purposes than for regular tax purposes. Therefore, some adjustments may have to be made in your depreciation deductions, and in the gain or loss on the sale of this property.

(10) Depletion. For AMT purposes, depletion is allowed only to the extent of your adjusted basis for the property.

(11) Other preferences. Other types of preferences may apply depending on your particular tax situation. Please call if you would like me to review your overall tax situation from the AMT perspective.

Exemption amounts. As noted above, in computing your AMT, after you arrive at AMTI, you subtract an exemption amount. For single taxpayers, the exemption amount for 2009 was $46,700. However, you must reduce the exemption by 25% of the amount by which AMTI exceeds $112,500. For married taxpayers filing jointly and surviving spouses, the 2009 exemption amount was $70,950, and the 25% reduction started when AMTI exceeds $150,000.  For 2010, unless Congress passes legislation, the exemption amount drops to $33,750 for single filers and $45,000 for joint filers subjecting many more taxpayers to the AMT tax.

A nonrecurring spike of income—for example, the recognition of a significant amount of capital gains in a year—might trigger the phaseout (under the 25% reduction rules discussed above) of your AMT exemption, which could result in an AMT liability. This could happen even though, as mentioned above, the AMT rates on long-term capital gains and qualified dividend income are the same favorable rates that apply for regular tax purposes. The inclusion of long-term capital gains in your taxable income, as well as in your AMTI, might also affect your entitlement to various deductions and credits, and the amounts of AMT preferences and adjustments, that vary or phase out depending on the amount of your income.

AMT credit. Once you are subject to the AMT, you may be entitled to a credit (the “minimum tax credit” or “AMT credit”) which can reduce your tax liability in the future. You generally can’t use the minimum tax credit to get a tax refund. However, a partial refund is available for credits that haven’t been used after three tax years.

Costs of long-term care and insurance qualify as medical expense

The costs of “qualified long-term care” and insurance coverage for such care qualify as deductible medical expenses. Since nursing home care can be so expensive and insurance for such care is growing in popularity, this deduction may apply to many taxpayers.

“Qualified long term care” services are necessary diagnostic, preventive, therapeutic, curing, treating, mitigating, and rehabilitative services, and maintenance or personal care services required by a chronically ill individual provided under a plan of care presented by a licensed health care practitioner.

To qualify as chronically ill, an individual must be certified by a physician or other licensed health care practitioner (e.g., nurse, social worker, etc.) as unable to perform without substantial assistance at least two activities of daily living for at least 90 days due to a loss of functional capacity, or as requiring substantial supervision for protection due to severe cognitive impairment (memory loss, disorientation, etc.). Of course, a victim of Alzheimer’s disease qualifies.

“Qualified long term care insurance” is insurance that provides coverage only for qualified long term care services, doesn’t pay costs that are covered by Medicare, is guaranteed renewable, and doesn’t provide for a cash surrender value. A policy isn’t disqualified merely because it pays benefits on a per diem or other periodic basis without regard to the expenses incurred during the specific payment period. 

The 2010 limits on deductible long-term care insurance premiums are: $330 per year for individuals 40 years old or younger; $620 over 40 to 50; $1,230 over 50 to 60; $3,290 over 60 to 70; and $4,110 over 70. Thus, for 2010, a married couple filing jointly each of whom is over 70 can deduct up to $8,220 a year in premiums. (These limits apply solely to long-term care insurance premiums. No limits apply to directly incurred long-term care expenses.)

Please note that the costs of qualified long term care or insurance for such care aren’t necessarily deductible for all taxpayers. These rules merely state that they may be included in deductible medical expenses. These are only deductible to the extent they exceed 7.5% of adjusted gross income (the normal floor for all medical expenses). For example, if a married couple filing jointly has adjusted gross income of $80,000, only medical costs in excess of $6,000 ($80,000 × 7.5%) may be claimed as an itemized deduction.

In determining your total medical costs, however, be sure to include those that you incur for your dependents as well as for yourself. For example, a taxpayer undertaking to cover the long-term care of an elderly parent or grandparent may be able to include these costs along with his own medical expenses on his return. They may be included if the parent or grandparent is the taxpayer’s dependent. For these purposes, the test will generally be met if the taxpayer is providing over 50% of the support of the parent or grandparent (including medical costs). (The taxpayer may not be able to claim a dependency exemption if the parent or grandparent has gross income above $3,650 in 2010 or is filing a joint return, but will still be able to include the medical costs with his own.)

Key developments during the second quarter of 2010

While the new law tax changes in the health reform legislation and the hiring legislation were the most significant developments in the first quarter of 2010, many other tax developments may affect you, your family, and your livelihood. These other key developments in the first quarter of 2010 are summarized below.

Estate planning uncertainty. As of now, there is no estate or generation-skipping transfer tax for individuals who die this year. Because of changes to the income tax basis rules for property acquired from a decedent in 2010, some heirs could actually face higher combined estate and income tax costs if their loved one dies in 2010 than would have been the case if death had occurred in 2009. Congress could still retroactively reinstate the estate and generation-skipping transfer taxes to the beginning of this year and restore the favorable prior basis rules that wipe out income tax on pre-death appreciation in asset values. But, so far, there is no clear indication of what lawmakers will do. Apart from tax uncertainty, the continuing inaction could also pose a problem for individuals with wills using formula clauses. These clauses work well when the estate tax is in force but they may produce unintended consequences when there is no estate tax. Action may need to be taken if it becomes clear that Congress will not be addressing the situation.

Like-kind exchange relief for those snared by QIs in bankruptcy or receivership. In general, no gain or loss is recognized on the exchange of property held for productive use in a trade or business or for investment if the property is exchanged solely for property of a like kind which is held either for productive use in a trade or business or for investment. When a taxpayer uses a qualified intermediary (QI), generally he will transfer the relinquished property to the QI, who will sell the property to a buyer. The QI will then take the proceeds of the sale of the relinquished property, purchase the replacement property, and transfer the replacement property to the taxpayer. If the taxpayer receives the replacement property within a specified period and meets other requirements, he is considered to have engaged in a like-kind exchange of property with the QI and he won’t recognize gain on the exchange.

Unfortunately, many QIs went bankrupt in the last few years thus posing a problem for taxpayers who used them. However, the IRS has now granted relief for taxpayers who were unable to timely complete a like-kind exchange because their QI entered into bankruptcy or receivership. The IRS won’t treat taxpayers as being in actual or constructive receipt of exchange proceeds if they can’t complete an exchange because of a default of a QI in bankruptcy or receivership. Affected taxpayers may use a special safe harbor method to report gain or loss.

Reporting of uncertain tax positions. IRS has released a draft schedule and instructions under which, beginning with the 2010 tax year, certain business taxpayers with both uncertain tax positions and assets of $10 million or more will be required to file Schedule UTP if they or a related party issued audited financial statements. Currently, the reporting requirement applies to corporations required to file a Form 1120, insurance companies required to file a Form 1120L or a Form 1120 PC and foreign corporations required to file a Form 1120F. The schedule is filed together with the taxpayer’s annual tax return and includes a concise description of each uncertain tax position and information on the maximum amount of potential federal tax liability attributable to each uncertain tax position.

Chances of being audited. The IRS has issued its annual data book, which provides statistical data on its fiscal year 2009 activities, including how many tax returns it examines (audits), and what categories of returns it focuses its resources on. Of the 138,788,744 total individual income tax returns with a filing requirement (this excludes returns filed only to receive an economic stimulus payment) in calendar year 2008, 1,425,888 (1%) were audited. For business returns other than farm returns showing total gross receipts of $100,000 to $200,000, 4.2% of returns were audited. For business returns other than farm returns showing total gross receipts of $200,000 or more, 3.2% of returns were audited. For returns showing total positive income of $200,000 to $1 million, 2.3% of returns not showing business activity were audited, and 3.1% of returns showing business activity were audited.

IRS honoring medical resident FICA refund claims for pre-April 1, 2005 periods. The IRS made an administrative determination to accept the position that medical residents are excepted from FICA taxes based on the student exception for tax periods ending before April 1, 2005, when new IRS regulations went into effect. The IRS intends to contact hospitals, universities and medical residents who filed FICA (Social Security and Medicare tax) refund claims for these periods with more information and procedures. The period of limitations for filing a claim for tax periods before April 1, 2005 has expired. An individual who is or was a medical resident, and did not file an individual FICA refund claim, may be covered by a FICA refund claim filed by his employer for the period he was a medical resident. The individual should contact his employer (or former employer) to see if it filed a FICA refund claim. On April 1, 2005, new IRS regulations regarding the student FICA exception became effective. Under these regulations, an employee including a medical resident who works 40 hours or more for a school, college or university is not eligible for the student exception.

Payments for use of trademarks. A prestigious Federal Appellate Court has ruled that a corporation that manufactured kitchen knives and tools could currently deduct the royalties it paid under trademark licensing agreements. In so deciding the Appeals Court rejected the IRS’s position (which had been sustained in the lower court) that the payments had to be capitalized under complex statutory provisions. The immediate deduction produced a quicker tax break than would have been the case had the Appeals Court agreed with the IRS.

Boosted housing allowances for those working abroad in high-cost areas. Guidance from the IRS increases the maximum housing cost exclusion for some U.S. citizens and residents working abroad in specified high-cost locations in 2010. The increases are based on geographic differences in foreign housing costs relative to U.S. housing costs. For example, assume a U.S. taxpayer is posted to Tokyo, Japan for all of 2010. Under the new IRS guidance, his maximum housing cost exclusion is $93,260 ($107,900 full year limit on housing expense in Tokyo minus $14,640 base amount). Before the 2010 table was issued, the IRS had last issued a table for 2008, which is also used for 2009. However, the 2010 table can be used for 2009 if it produces a better result for the taxpayer. In some cases, the 2010 allowances are lower than the 2008 allowances.

Moratorium on enforcement of tax shelter penalty continues. Continuing a previously announced policy, the IRS has suspended through May 31, 2010 its efforts to collect penalties under IRC §6707A in some cases. This provision imposes a penalty of $100,000 per individual and $200,000 per entity for each failure to make special disclosures with respect to a transaction that the IRS characterizes as a “listed transaction” or “substantially similar” to a listed transaction. The suspension applies where the annual tax benefit from the transaction is less than $100,000 for individuals or $200,000 for other taxpayers. The IRS originally implemented the suspension after Congressional leaders complained that IRC §6707Aan result in disproportionate penalties for small businesses that thought they were investing in legitimate benefits plans, but unknowingly invested in listed tax shelter transactions. Legislation that would ease IRC §6707A’s application has passed the Senate and has been introduced in the House.

Government seeks input on annuitization of retirement plan payments. The Department of Labor and the Department of the Treasury are currently reviewing the law to determine whether (and, if so, how) they could or should enhance the retirement security of participants in employer-sponsored retirement plans and IRAs by facilitating access to, and use of, lifetime income or other arrangements designed to provide a lifetime stream of income after retirement. To that end, they are seeking input on this subject from plan participants, employers and other plan sponsors, plan service providers, and members of the financial community, as well as the general public. The concern is that many employers no longer provide fixed lifetime pensions but rather provide 401(k) plans. With these plans, employees bear investment risks and can choose lump sums. Accordingly, employees are not only increasingly responsible for the adequacy of their savings at the time of retirement, but also for ensuring that their savings last throughout their retirement years.

Taking Your Business to the Next Level with Key Performance Indicators

Critical Success Factors

Every business, large or small, regardless of what it does, depends for its survival on getting certain things right on a regular basis. These things we call the Critical Success Factors. (CSFs)

These CSFs relate to the business processes and activities that really drive business results. At the top level these are:

• Processes and activities that are important to acquiring and holding customers
• Processes and activities that determine revenue
• Processes and activities that impact on efficiency and productivity
• Processes and activities that determine team morale

To know how well your business is managing these CSFs, you need a system of measurement. In effect, Key Performance Indicators ARE these measures.  So it’s important to understand how you can develop a set of KPIs that will allow you to monitor performance on these critical processes and activities.

Measuring To Compare And Assess Goal Achievement

Measuring to determine goal achievement and to make comparisons to see how you stand relative to others is really the only point of going to the effort of measuring. In these cases, you have set some goal to achieve, whether it be based on what you have achieved previously, or on an industry benchmark you want to match. In these cases you can use the information to assess how well you are doing in reaching a specific goal.

Depending on that figure, you will know if you need to fine-tune your strategy or not. That is the real point of keeping measures – to be able to monitor business performance and know where you could improve it. The point is, that before you decide to arbitrarily start measuring things, you should take a step back and think about what your goals are in each area – give yourself a target to aim at.

Selecting KPIs To Monitor

There are literally hundreds of KPIs that could be used to track your business’ performance. You may be familiar with some KPIs even though you haven’t thought of them as such. For instance, the value of production output per employee and your gross profit margin both measure some aspect critical to the success of your operations and can be considered as KPIs. But KPIs are not necessarily those things you measure in dollars. Many equally critical activities, such as ensuring customer loyalty, can’t be measured in dollars and cents, so there are in fact many non-financial KPIs as well.

The key to effective measurement though, is to identify just a small number of KPIs, (say 6-8), that measure the most critical activities – and to watch them like a hawk.

A business’ overall goal could translate into a set of goals for different activities. With cash flow, for sales activities this might be simply to ‘increase sales by 2% each quarter’, or whatever. Achieving this will help the business achieve better cash flow. The KPI for this will be gross sales value.

So, suppose we’re monitoring gross sales and we note that it’s not improving. What do we do? Well, you can’t pinpoint exactly where you need to focus your corrective action if you are unsure of why gross sales have dipped. But you can actually determine that by having set up some KPIs to measure the activities around sales itself. By looking at these sub-system KPIs of sales we have a better opportunity to identify the real issue.

Generally, sales are made by obtaining sales leads, and converting those to actual sales. By looking at the sub-system of gross sales…the leads generated and the leads converted…we can quickly see what area isn’t performing. We are then able to take action based on whether we need to address our advertising and marketing to generate leads, or whether or not it is our sales process and methods that need work.

We can then decide if we require additional information, and what type of additional information is required, in order to make a more informed decision. Say, for example, that conversion rates were dropping; we may then need to dig further into differences in sales people’s conversion rates or even look at seasonal comparisons. If we are routinely keeping this type of information we are able to notice trends and react much faster to changed circumstances.

For KPIs to be useful in the management process they need to be compiled and reviewed on a regular basis. How regularly individual KPIs are monitored is dependent on the KPI itself and the process it is measuring. The general rule is that the further down the process level of the organization, the more focused on specific functional activity, the greater the frequency of the reporting.

The frequency of reporting becomes more evident once a KPI is defined. There is absolutely no point having a KPI reported on daily, when nobody looks at it for 30 days or if there is nothing that can be done to adjust the process anyway.

Still, at the manager level a lot of numbers ought to be checked regularly – sales for the previous day, the backlog of orders or deliveries, how much inventory is available and so on. All can provide early warning of developing problems and allow them to be dealt with.

Actions to achieve KPI targets may actually conflict with each other in terms of achieving the overall plan. For example, the goal to minimize inventory stocks may jeopardize another goal such as improving customer order fill-rate. You still set up the KPIs, but you need to consider the strategies for achieving the individual goals so the overall plan is not damaged.

Another example: If the goal was to build gross sales, the sales team might achieve it through massive discounting. Therefore, if one of your KPIs here was ‘number of sales per salesperson’ it might look pretty good. But obviously it’s not a viable strategy and you’d need to have either ruled out discounting as a strategy from the beginning, or maintain KPIs on net margins, gross margins and cost per sale, to ensure it didn’t get out of hand. The way you choose to improve a critical number has to be consistent with the overall business plan.

In summary, that is how to create KPIs. As we mentioned earlier, we gather KPIs for a reason – and that reason is to improve business performance. The basis of improving is monitoring.

There are 3 main ways of monitoring performance:

1. Have a business plan to guide your activities.
2. Carry out regular financial analyses of operations.
3. Benchmark your activities against other businesses or the industry to see how you stand.

Each of these will provide you with the essential underpinnings of a useful KPI system – goals you want to achieve. Knowing the goal allows you to identify CSFs; and knowing your CSFs points to the KPIs you will need to track.

Having a documented business plan provides the opportunity to set out just what you want your business to achieve and how you will go about getting there. In doing this exercise you gain a very realistic appreciation of your market, your competitive positioning and your capabilities. Furthermore, a good marketing plan will also develop some realistic goals to aim for and these become the targets for the KPIs you measure. Therefore, you know that the KPIs you are monitoring are the right ones for showing if the business is going in the direction your plan has set out.

We also recommend that you have a set of key financial ratios prepared on a regular basis as well – not just your profit and loss account and balance sheet but also a detailed monthly cash flow analysis for instance. Your financials form a major set of KPIs for your business.

Remember that KPIs relate only to your own company – they measure how your operations are working out; so many sales per salesperson, so many days in receivables etc. Apart from the fact that these might show you are moving in the right direction, what do they say about how you stand with regard to what other firms are achieving?

If you take the KPI figures from a number of similar firms and use them to construct a chart showing the average figure for poor performing firms, the industry average overall, and how the best performers rate, then you have a benchmark against which you can compare your own performance. This kind of information can provide you with the target figures you use for your KPIs.

What’s new in back-to-school tax savings?

It is no secret to students, working individuals going back to school, and their families that the cost of education is becoming continuously more expensive year after year. The Tax Code provides a variety of significant tax breaks to help pay for the rising costs of education, from elementary and secondary school to college and graduate school. Individuals may be surprised to learn the many different ways the tax laws can help make education more affordable these days. In addition to scholarships, loans and work-study grants, or simply by themselves, these incentives can provide valuable cost savings.

 Lifetime Learning Credit

The Lifetime Learning credit can be claimed for qualified tuition and fees paid by an individual for his or her (or a spouse’s or dependent’s) enrollment at any college, university, vocational school, or postgraduate school. The credit is equal to 20 percent of up to $10,000 of the qualified tuition and related expenses paid by a taxpayer during the tax year. Thus, the maximum credit amount per taxpayer return is $2,000.

The Lifetime Learning credit can be claimed for all years of postsecondary school (as well as for courses to acquire or improve job skills). However, the credit phases out as your modified AGI rises, and you can not claim the credit if you are married filing separately. You cannot claim a credit if your modified AGI is $60,000 or more ($120,000 or more if you file a joint return).

American Opportunity Tax Credit

The American Opportunity Tax Credit (AOTC), which was previously the Hope scholarship credit but temporarily enhanced and renamed the AOTC for 2009 and 2010, can also be claimed for qualified tuition and fees paid by an individual for his or her (or a spouse’s or dependent’s) enrollment or attendance at any college, university, vocational school or postgraduate school.

The AOTC can be used for all four years of post-secondary school. Further, the credit can be taken for more expenses, such as text books and course materials. And, although the credit phases out as adjusted gross income (AGI) rises, the income phase out range is increased through 2010 as well. Additionally, 40 percent of the credit is refundable.

 For 2010, the AOTC is available up to a maximum of $2,500 per eligible student, per year (100 percent of the first $2,000 eligible expenses plus 25 percent of the next $2,000 eligible expenses). The credit phases out at higher income levels, making the credit available to more families as well. The amount of the credit begins to phase out when an individual’s AGI falls between $80,000 to $90,000 AGI. For married joint filers the credit phases out when AGI falls between $160,000 and $180,000.

 AOTC vs. Lifetime Learning credit

The AOTC and Lifetime Learning credits cannot both be taken for the same student in the same year. If you pay the qualified education expenses of more than one student in the same year, however, you can choose to take the credits on a per-student basis for that year (for example, you may claim the AOTC for your daughter and the lifetime learning credit for your son, etc). You should calculate the effect of the AOTC, Lifetime Learning Credit (and, if retroactively reinstated for the 2010 year, the higher education expense deduction) on your tax return to see which incentive achieves the greatest tax savings. Remember, also, in “doing the math” that the tax benefits are based on calendar tax years and not school academic years.

Coverdell Education Savings accounts

Individuals can contribute up to $2,000 a year to a Coverdell Education Savings account, which is established to help pay for the costs of education of an account beneficiary. A beneficiary is someone who is under age 18 or with special needs.

Although contributions to a Coverdell account are not deductible, earnings grow tax-free, and distributions are also tax free if used for qualified education expenses, including tuition and fees, required books, supplies and equipment, as well as qualified expenses for room and board. The account can help pay for the costs of attending an elementary or secondary school, whether public, private or religious, as well as a college or university.

As with the education credits, there are contribution limits based on the contributor’s modified AGI.

IRA withdrawals for education expenses

Generally, if you take a distribution from your IRA before you reach age 59 1/2 you must pay a 10 percent additional tax on the early distribution, as well as income tax on the amount distributed. This applies to any IRA you own, whether it is a traditional IRA, a Roth IRA or a SIMPLE IRA. However, you can take an IRA distribution before age 59 1/2 and avoid the 10 percent tax (but not the inclusion of the distributed amount in income for income tax purposes), if the distribution is used to pay the qualified education expenses for:

• Yourself;
• Your spouse; or
• Your or your spouse’s child, grandchild or foster child.

The amount of the withdrawal is generally limited to $10,000. Qualified education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at any college, university, vocational school or other post-secondary educational institution. In addition, if the student is at least a part-time student, room and board are generally qualified education expenses, subject to certain limitation.

Section 529 college savings plans

Qualified tuition programs, more commonly referred to as 529 plans, allow you to either prepay education expenses or contribute to an account set up for paying a student’s qualified education expenses at eligible educational institutions. A 529 plan allows you to save money, tax-free, to pay for qualified education expenses for college. Although contributions are not deductible for federal tax purposes, many states allow residents to deduct contributions on their state tax return. Moreover, withdrawals from a 529 plan are tax-free unless the amount distributed is greater than the account beneficiary’s adjusted qualified education expenses. Qualified education expenses include amounts paid for tuition, fees, books, supplies and equipment, as well as reasonable costs of room and board for individuals are at least part-time students.

Computer and technology expenses. Through 2010, parents and students can take tax-free withdrawals from their 529 plans to buy computers and computer-related equipment for college. The 2009 Recovery Act added computers, computer equipment, technology, internet access, and “related services” to the list of qualified higher education expenses that can be paid for with tax-free 529 withdrawals. However, as with the AOTC, this expanded incentive is temporary and applies only through 2010 (unless Congress extends this tax break). However, tax-free withdrawals can not be taken for computer software designed for games, sports or hobbies, unless the software is “predominantly educational in nature.”

Caution. While the tax law allows you to combine the tax benefits of a 529 plan with one of the education credits or deductions, you cannot “double dip.” That is, the expenses you use to compute the AOTC (or Lifetime Learning Credit) cannot also be included as a qualified higher education expense for purposes of determining your tax exclusion for 529 plan withdrawals. Remember, too, that states have their own rules regarding education benefits, such as withdrawals from 529 plans. These must be considered as part of your education tax savings strategy.

Student loan interest deduction

Eligible individuals can take an above-the-line deduction for up to $2,500 of interest paid on student loans used to pay for the cost of attending any college, university, vocational school, or graduate school. A student loan, for purposes of the deduction, is a loan you took out and is designated solely to pay your (or your spouse’s or dependent’s) qualified education expenses. For example, if you take out a home equity loan to pay for college tuition, the interest may be deductible as mortgage interest, but it is not considered above-the-line interest for a student loan since the lender did not specifically restrict the proceeds to education expenses.

Good news on student loan interest, however, is that qualified education expenses include not only tuition and fees, but also room and board, books, supplies and equipment, and other necessary expenses such as transportation. Interest paid on a loan that is made to you by a related person, such as parents or grandparents, or from a qualified employer plan do not qualify for the deduction.

The deduction is available regardless of whether or not you itemize. The amount of the deduction begins to phase out when an individual’s modified AGI exceeds $55,000 a year (or $115,000 for married couples filing jointly). The deduction is completely eliminated once an individual’s modified AGI reaches $70,000 (or $145,000 for joint filers). If you are claimed as a dependent on another’s tax return, you can not take the deduction, however.

Expired incentives hanging in the wings

At the end of 2009, two popular, but temporary, tax incentives expired: the higher education tuition deduction and the teachers’ classroom expense deduction of up to $250. Congress is working on legislation to extend these benefits through 2010. We will keep you posted on its progress.

What the new 1099 reporting requirement will mean for businesses

Businesses of all sizes are preparing for a possible avalanche of information reporting after 2011. To help pay for health care reform, lawmakers tacked on expanded information reporting to the Patient Protection and Affordable Care Act (PPACA). The health care reform law generally requires all businesses, charities and state and local governments to file an information return for all payments aggregating $600 or more in a calendar year to a single provider of goods or services. The PPACA also repeals the longstanding reporting exception for payments to a corporation. The magnitude of the reporting requirement has opponents working feverishly to persuade Congress to either repeal it or scale it back.Pre-PPACA law Pre-PPACA law generally requires businesses to file an information return with the IRS reporting payments to non-corporate service providers that exceed $600 in a given year. Payments to providers of goods are excluded from reporting. Payments to a corporation for goods or services are excluded from reporting with some limited exceptions. Sea change ahead Effective for purchases made after December 31, 2011 the PPACA requires all businesses purchasing $600 or more in goods or services from another entity (including corporations but not tax-exempt corporations), to provide the vendor and the IRS with an information return. Presumably, Form 1099-MISC will be used for purposes of the new reporting rule, or the IRS will develop a new form. We will keep you posted on developments. Example. In February 2012, your business buys computers, printers, and fax machines from an office supply company, doing business as a corporation, for $4,000. Your business also spends $1,000 at a local caterer, doing business as a partnership, for office breakfasts and lunches throughout the year. Additionally, the company spends $600 for business travel on Amtrak. Your business must provide each of these vendors with a Form 1099 for 2012, as well as the IRS. Day-to-day transactions Here are some more examples of purchases after 2011 that appear to fall under the PPACA’s reporting requirements: – You make small, incremental purchases from the same vendor; for example, your business purchases more than $600 of office supplies, such as staples, toner, pens, paper, and calendars from the same vendor. – You pay more than $600 throughout the year in mail and shipping costs to the same vendor; however each individual charge costs no more than $10 or $12. – You purchase floral arrangements for the office throughout the year, although each purchase may be no more than $40 to $70, your cumulative purchases are more than $600; – You purchase an $800 computer for your new employee; – You hold a summer picnic for your employees and purchase more than $600 in food from a local grocery store; – Every Friday you buy breakfast pastries from the local bakery for your employees, and even though each purchase is no more than $40, you spend more than $600 in the year. Backup withholding The PPACA requires sellers to provide, and purchasers to collect, Taxpayer Identification Numbers (TINs). If a seller fails to furnish a correct TIN, you must impose backup withholding at the rate of 28 percent of the purchase price. Moreover, if your business fails to issue an accurately completed Form 1099 to a vendor, the IRS can assess a penalty. Preparing now There are some proactive steps your business can take now to prepare for the new reporting requirement and its heavy administrative and paperwork burden. The way you collect and manage vendor information will be more important than ever. Basic information you will need to track includes every vendor’s name and TIN, the amounts spent at each vendor and the total annual amount spent at each vendor. You should also begin requesting that each of your vendors, particularly your regular vendors, complete IRS Form W-9 for your records. Form W-9 will provide you with the vendor’s legal name, address, and TIN. Pending legislation Opponents of the expanded information requirement are hoping that Congress will repeal it before 2012. Outright repeal is a long-shot. As written now, the PPACA reporting requirement is estimated to raise $17 billion over 10 years. Congress will need to find another source of revenue if it repeals the reporting requirement. More likely, Congress will modify the requirement. Senate Democrats have introduced legislation to raise the reporting threshold from $600 to $5,000 and exclude some routine payments, such as office supplies, from reporting. All purchases made with a credit card would also be exempt from the reporting requirement. Additionally, small businesses employing not more than 25 employees would be completely exempt from the reporting requirement. Congress may scale back the PPACA’s reporting requirements in the autumn of 2010. We will keep you posted on developments.

What will the income tax rate be in 2011?

Only three months remain until the current marginal individual income tax rates that helped lower the tax rates of all taxpayers, from lower to middle to higher-income individuals and families, over the past ten years will expire. Congress has a number of options on the table, with some lawmakers favoring extension of the current rates for all taxpayers, while others favor only extending the current rates for the middle-class, and allowing the top two rates to revert to their previous higher levels. Still others are willing to extend none of the rates if a stalemate over the higher rate brackets ensues. The potential rate change makes tax planning all the more important, yet tax planning is also made uncertain by inaction on Congress’s part.

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) gradually reduced the individual marginal income tax rates across the board and created a new – but temporary – 10 percent regular income tax bracket for a portion of taxable income that was previously taxed at 15 percent. These so-called “Bush tax cuts” – named after the Administration in which they first appeared – could only be placed into the Tax Code for a 10-year duration due to procedural rules in place at the time. As a result, those tax cuts expire at the end of 2010 and beginning in 2011, those income tax rates, as well as other individual tax cuts will revert back to pre-2001 levels.

Federal individual income tax rates for 2010 are:

Single individuals: If taxable income is:
- Not over $8,375: 10% of the taxable income;
- Over $8,375 but not over $34,000: $837.50 plus 15% of the excess over $8,375;
- Over $34,000 but not over $82,400: $4,681.25 plus 25% of the excess over $34,000;
- Over $82,400 but not over $171,850: $16,781.25 plus 28% of the excess over $82,400;
- Over $171,850 but not over $373,650: $41,827.25 plus 33% of the excess over $171,850; and
- Over $373,650: $108,421.25 plus 35% of the excess over $373,650.

Married couples filing a joint return: If taxable income is:
- Not over $16,750: 10% of the taxable income;
- Over $16,750 but not over $68,000: $1,675 plus 15% of the excess over $16,750;
- Over $68,000 but not over $137,300: $9,362.50 plus 25% of the excess over $68,000;
- Over $137,300 but not over $209,250: $26,687.50 plus 28% of the excess over $137,300;
- Over $209,250 but not over $373,650: $46,833.50 plus 33% of the excess over $209,250; and
- Over $373,650: $101,085.50 plus 35% of the excess over $373,650.

Unless extended (or made permanent, which is not likely at this time), all the individual marginal income tax rates will rise after December 31, 2010. The 10 percent regular income tax bracket will disappear and the first part of an individual’s taxable income will be taxed at 15 percent rather than at 10 percent.

After EGTRRA sunsets (after December 31, 2010) and without any modification by Congress, the federal individual income tax rates for 2011 will be:

Single individuals: If taxable income is:
- Not over $34,850: 15% of the taxable income;
- Over $34,850 but not over $84,350: $5,227.50 plus 28% of the excess over $34,850;
- Over $84,350 but not over $176,000: $19,087.50 plus 31% of the excess over $84,350;
- Over $176,000 but not over $382,650: $47,499 plus 36% of the excess over $176,000; and
- Over $382,650: $121,893 plus 39.6% of the excess over $382,650.

Married couples filing a joint return: If taxable income is:
- Not over $58,200: 15% of the taxable income;
- Over $58,200 but not over $140,600: $8,730 plus 28% of the excess over $58,200;
- Over $140,600 but not over $214,250: $31,802 plus 31% of the excess over $140,600;
- Over $214,250 but not over $382,650: $54,633.50 plus 36% of the excess over $214,250; and
- Over $382,650: $115,257.50 plus 39.6% of the excess over $382,650.

President Obama wants a permanent extension of the current 10, 15, 25, and 28 percent rates. Under his proposal, these rates would continue for individuals without interruption after December 31, 2010. He would also raise the cut off level for the 28 percent bracket. However, the 33 percent rate bracket and the 35 percent rate bracket become 36 percent and 39.6 percent, respectively, after December 31, 2010.

Under the president’s proposal, the individual income tax rates for 2011 would be:

Single individuals: If taxable income is:
- Not over $8,575: 10% of the taxable income;
- Over $8,575 but not over $34,850: $858 plus 15% of the excess over $8,575;
- Over $34,850 but not over $84,350: $4,799 plus 25% of the excess over $34,850;
- Over $84,350 but not over $195,550: $17,174 plus 28% of the excess over $84,350;
- Over $195,550 but not over $382,650: $48,310 plus 36% of the excess over $195,550; and
- Over $382,650: $115,666 plus 39.6% of the excess over $382,650.

Married individuals filing a joint return: If taxable income is:
- Not over $17,150: 10% of the taxable income;
- Over $17,150 but not over $69,700: $1,715 plus 15% of the excess over $17,150;
- Over $69,700 but not over $140,600: $9,598 plus 25% of the excess over $58,200;
- Over $140,600 but not over $237,300: $28,472 plus 28% of the excess over $140,600;
- Over $237,300 but not over $382,650: $55,548 plus 36% of the excess over $237,300; and
- Over $382,650: $106,725 plus 39.6% of the excess over $382,650.

With uncertainty remaining as to the state of the tax rates for 2011, tax planning can be made significantly more difficult. However, a number of tax strategies, such as accelerating income into 2010 to avoid possible higher rates next year, can be implemented now even in these uncertain times.

Individual and business tax incentives in the Small Business Jobs Act of 2010

Congress has passed a small business jobs bill, the Small Business Jobs Act of 2010 (H.R. 5297), with valuable individual and business tax incentives totaling approximately $12 billion. Many of these tax incentives are temporary so you have only a short window of time in which to take advantage of them. Other tax incentives are permanent but require careful planning to maximize your tax benefits. General business provisions Bonus depreciation. An additional first-year depreciation deduction equal to 50 percent of the adjusted basis was available for qualified property placed in service in 2008 and 2009 (2009 and 2010 for certain longer-lived property and transportation property). The new law extends bonus depreciation for qualified property acquired and placed in service during 2010 (or placed in service during 2011 for certain longer-lived property and transportation property). The new law also includes a special long-term accounting rule for bonus depreciation. Code Sec. 280F. The limitation under Code Sec. 280F on the amount of depreciation deductions allowed with respect to certain passenger automobiles is increased in the first year they are used in a business by $8,000 for automobiles that qualify and for which the taxpayer does not elect out of the additional first-year deduction. For 2010, therefore, maximum first-year depreciation for passenger automobiles is $11,060. Code Sec. 179 expensing. The new law increases the maximum amount a taxpayer may expense under Code Sec. 179 to $500,000 and raises the phase-out threshold to $2 million. Enhanced Code Sec. 179 expensing is available for tax years beginning in 2010 and 2011. The new law also allows taxpayers to expense qualified leasehold investment property, qualified restaurant property and qualified retail improvement property. The maximum amount with respect to real property that may be expensed, however, is limited to $250,000. Start-up business expenses. A certain amount of qualified business start-up expenses may be deductible in the tax year in which the active trade or business begins. The new law doubles the amount of start-up expenditures that a taxpayer may elect to deduct from $5,000 to $10,000 for tax years beginning in 2010. The new law also increases the deduction phase-out threshold so that the $10,000 is reduced, but not below zero, by the amount by which the cumulative cost of qualified start-up expenses exceeds $60,000. S corporation built-in gains tax. A C corporation that converts to an S corporation generally must hold any appreciated assets for 10 years following the conversion or, if disposed of earlier, pay tax on the appreciation at the highest corporate level rate (currently 35 percent). The American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) temporarily shortened the usual 10-year holding period to seven years for dispositions in tax years beginning in 2009 and 2010. The new law further shortens the holding period to five years in the case of any tax year beginning in 2011, if the fifth year in the recognition period precedes the tax year beginning in 2011. Cell phones. In 1989, the IRS identified employer-provided cell phones as “listed property.” For listed property, no deduction is allowed unless a taxpayer adequately substantiates the expense and business usage of the property. The listed property designation was imposed on cell phones when they were novel, expensive, and not many individuals owned one. The new law removes cell phones from the definition of listed property for tax years beginning after December 31, 2009. Small business provisions Small business stock. To encourage investment in small businesses, the American Recovery and Reinvestment Act of 2009 temporarily increased the percentage exclusion for qualified small business stock acquired after February 17, 2009 and before January 1, 2011 to 75 percent. The new law raises the exclusion to 100 percent for qualified stock issued after the date of enactment and before January 1, 2011. The stock must be acquired at original issue from a qualified small business and held for at least five years. General business credit. The new law extends the carryback period for eligible small business credits from one to five years. Eligible small business credits are defined for purposes of the new law as the sum of the general business credits determined for the tax year with respect to an eligible small business. An eligible small business is a corporation whose stock is not publicly traded, a partnership or a sole proprietorship. Additionally, the average annual gross receipts of the corporation, partnership, or sole proprietorship for the prior three tax year periods cannot exceed $50 million. The extended carryback provision is effective for credits determined in the taxpayer’s first tax year beginning after December 31, 2009. Code Sec. 6707A penalty relief. The new law reforms the Code Sec. 6707A penalty regime retroactively for taxpayers failing to disclose participation in reportable and listed transactions. Generally, the penalty would equal 75 percent of the reduction in tax reported on the participant’s return as a result of the transaction or that would result if the transaction was respected for federal tax purposes. Under the new law, the maximum penalty for an individual for failing to disclose a reportable transaction is $10,000 ($100,000 in the case of a listed transaction). The maximum penalty for all other taxpayers for failing to disclose a reportable transaction is $50,000 ($200,000 for all other persons). Individual tax incentives Retirement savings. The new law includes several provisions to encourage retirement savings. With many employees now saving for retirement using 401(k) plans, the new law provides a major Roth conversion option that can mean significantly more dollars available at retirement. Under the new law, if a Code Sec. 401(k), 403(b) or governmental 457(b) plan now sets up a qualified designated Roth contribution program, a distribution to an employee or surviving spouse from a non-designated Roth account under a plan may be rolled over to a designated Roth account within the same plan. The planning challenge in such a rollover conversion to a designated Roth account is that the converted balance is considered taxable income at the time of conversion, requiring tax to be paid either from the proceeds themselves or from cash otherwise available to the taxpayer. If an amount is rolled over in 2010, however, the new law helps ease that tax liability by treating the taxable converted amount as included ratably in income in equal amounts for 2011 and 2012 unless the taxpayer elects otherwise. The designated Roth provisions in the new law are effective immediately. Self-employment. Individuals who are self-employed may claim a deduction for qualified health insurance costs for income tax purposes. For self-employment taxes, the self-employed individual cannot deduct any health insurance costs. The new law allows the deduction for the cost of health insurance in calculating net earnings from self-employment for purposes of self-employment (FICA) taxes. The provision is temporary and only applies to the self-employed taxpayer’s first tax year beginning after December 31, 2009. The new law also allows partial annuitization of a nonqualified annuity contract. Holders of nonqualified annuities (annuity contracts held outside of a tax-qualified retirement plan or IRA) may elect to receive a portion of the contract in the form of a stream of annuity contracts, leaving the remainder of the contract to accumulate income on a tax-deferred basis. Only a portion of an annuity, endowment or life insurance contract may be annuitized while the balance is not annuitized. The annuitization period must be for 10 years or more, or for the lives of one or more individuals. The annuitization provision in the new law is effective for amounts received in tax years beginning after December 31, 2010. Annuitization requires careful planning; please contact our office for details. Rental property expense payments Among the new law’s revenue raising provisions is a new information reporting requirement that affects recipients of real estate rental income. Rental income recipients making payments of $600 or more to a service provider will file an information return with the IRS and the service provider. The new  law  permits  the IRS to exclude individuals for whom reporting would be a hardship and individuals who receive only minimal amounts of rental income from the requirement. Certain members of the military and intelligence services are also excluded. The reporting provision applies to payments made after December 31, 2010.

Health care reform: six months later

September 23, 2010 was the six-month anniversary of the comprehensive health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act). The date was more than a symbolic anniversary; it also marked the implementation date of many important provisions in the new law affecting adults, children, employers and health plans.

Implementation

Health care reform is being implemented by the U.S. Department of Treasury and the IRS; the U.S. Department of Labor (DOL) and the U.S. Department of Health and Human Services (HHS). The three agencies have issued joint guidance in many areas since passage of the health care reform package. Recently, the three agencies reiterated that their approach to implementing health care reform is “marked by an emphasis on assisting, rather than imposing penalties on, plans, issuers and others that are working in good faith to understand and come into compliance with the new law.” The three agencies noted that their approach may include transition relief, safe harbors and other policies to ensure that the new law takes effect smoothly.

Young adults

The health care reform package requires group health plans that provide dependent coverage for children to continue to make the coverage available for an adult child until the child turns 26 years of age with some exceptions. Plans are required to provide a 30-day period, no later than the first day of the plan’s next plan year that begins on or after September 23, 2010, to allow participants to enroll an adult child. Plans must notify participants of this enrollment opportunity in writing. Some plans began covering young adults voluntarily before the September implementation date.

Before passage of the health care reform package, employer-provided health insurance coverage was generally excluded from income if the employee’s child was under age 19 (or under age 24 if a student). The health care reform package extends the exclusion from gross income to any employee’s child who has not attained age 27 as of the end of the tax year. This tax benefit applies regardless of whether the plan is required by law to extend health care coverage to the adult child or the plan voluntarily extends the coverage. The income exclusion provision was effective March 30, 2010. The IRS, DOL and HHS issued regulations in July 2010.

Preventive services

The health care reform package prohibits cost-sharing (co-pays, co-insurance and deductibles) for preventative services for new plans beginning on or after September 23, 2010. Preventive services include:

• Blood pressure, diabetes and cholesterol tests
• Cancer screenings
• Counseling on smoking-cessation, weight loss, and other wellness endeavors
• Routine immunizations
• Preventive services for women
• Well-baby and well-child visits

If plan or issuer has a network of providers, it may impose cost-sharing requirements for recommended preventive services delivered by an out-of-network provider. However, health plans and insurers will not be able to charge higher cost-sharing (copayments or coinsurance) for emergency services outside of a plan’s network. The IRS, DOL and HHS issued regulations on cost-sharing for preventive services in July 2010.

Appeals

The health care reform package also expanded rights of individuals to appeal adverse determinations made by their health plans. New health plans beginning on or after September 23, 2010 must have an internal appeals process that allows individuals to appeal denials or reductions for covered services and rescissions of coverage. If an internal review denies an individual’s claim, the individual has the right to an external appeal.

Health plans must notify individuals of their right to appeal adverse determinations and the appeals procedures. Additionally, health plans are required to continue coverage pending the outcome of an individual’s internal appeal. The IRS, DOL and HHS issued regulations on the expanded appeal rights in July 2010. DOL recently issued a Technical Release that provides an enforcement grace period for compliance with certain new provisions with respect to internal claims and appeals.

Lifetime and annual limits

Lifetime limits on most benefits are generally prohibited in any health plan or insurance policy issued or renewed on or after September 23, 2010. The new law also restricts and phases out the annual dollar limits that all job-related plans, and individual health insurance plans issued after March 23, 2010, can put on most covered health benefits. None of these plans can set an annual dollar limit lower than:

• $750,000 for a plan year starting on or after September 23, 2010 but before September 23, 2011
• $1.25 million for a plan year or policy year starting on or after September 23, 2011 but before September 23, 2012
• $2 million for a plan year or policy year starting on or after September 23, 2012 but before January 1, 2014
• No annual dollar limits are allowed on most covered benefits beginning on January 1, 2014.

Other provisions

The health care reform package also prohibits group health plans and health insurance issuers from imposing pre-existing condition exclusions on children under 19 for the first plan year beginning on or after September 23, 2010. Additionally, insurers and plans will be prohibited from rescinding coverage except in cases involving fraud or an intentional misrepresentation of material facts for plan years beginning on or after September 23, 2010. Group health plans must also meet certain nondiscrimination requirements effective for plan years beginning on or after September 23, 2010. It should also be noted that all the September 23, 2010 deadlines apply to “plan years beginning on or after September 23, 2010″ so that, for example, a plan that runs on a calendar year would not be required to put these additional benefits in place until January 1, 2011.

Grandfathered plans

A grandfathered health plan is a plan that existed on March 23, 2010, the date of enactment of the Patient Protection and Affordable Care Act. Grandfathered plans, like new plans after September 23, 2010, must extend coverage to young adults under age 26; not place lifetime limits on coverage; not exclude coverage for children with pre-existing conditions; and not rescind coverage except in cases of fraud or an intentional misrepresentation of material fact.

Grandfathered plans may make certain changes to their plans, such as cost adjustments to keep pace with inflation, and not lose their grandfathered status. However, some changes, such as a significant reduction in employer contributions, will result in loss of grandfathered status.

Health care reform is one of the most extensive re-writings of the Tax Code and DOL and HHS rules in a generation. If you have any questions about the provisions we have discussed or other provisions in the health care reform package, please contact our office.

Fate of expiring tax incentives complicates year-end planning

Tax extenders

Many taxpayers mistakenly believe that some popular tax incentives are permanent when in reality they are temporary. It is no surprise that taxpayers make this assumption. Congress routinely allows these tax incentives (called tax extenders) to expire and then renews them. This year, the outcome may be different.

Congress has tried, and failed, several times in 2010 to renew the tax extenders. The House approved H.R. 4213 earlier this year but the bill has languished in the Senate over concerns about its price tag. The cost of the tax extenders, estimated as high as $30 billion, needs to be offset by revenue raisers. While the tax extenders are popular, many lawmakers are cautious about raising taxes of any kind in an election year. It is almost certain that Congress will not take up the tax extenders before the November elections. That leaves their fate to a lame duck session or the new Congress that will convene in January 2011.

Many of the tax extenders expired at the end of 2009. For individuals, the expired tax extenders include:

• State and local sales tax deduction
• Higher education tuition deduction
• Teachers’ classroom expense deduction
• IRA contributions to charity
• Conservation contributions of real property
• National disaster relief targeted to individuals

For businesses, the expired tax extenders include:

• Research tax credit
• Military differential pay credit
• 15-year recovery period for qualified leasehold improvements; qualified restaurant property and qualified retail improvement property.
• Indian employment credit
• Tax incentives for film and television production
• Brownfields remediation
• Tax incentives for mine rescue training and mine safety equipment
• Tax incentives for empowerment zones;
• Tax incentives for investment within the District of Columbia;
• Renewal community tax incentives
• New Markets Tax Credit

Expiring EGTRRA incentives

When Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), it not only reduced the individual income tax rates but also enhanced many popular tax breaks. However, like the reduced tax rates, the enhancements are temporary. Under current law, a number of tax incentives will revert to their pre-EGTRRA amounts; likely to the surprise of many taxpayers.

One of the tax incentives that will change the most is the child tax credit. For 2010, the child tax credit is $1,000 per qualifying child. After 2010, the child tax credit will fall to $500 per qualifying child. Other EGTRRA changes to the child tax credit, such as eliminating the supplemental child tax credit, will also disappear.

Along with the child tax credit, several other EGTRRA-enhanced tax incentives will significantly change after 2010. They include:

• Lower employment-related expense amounts for the dependent care credit
• Expiration of many taxpayer-friendly changes to the earned income credit
• Reduced contribution limits for Coverdell education savings accounts
• Lower income phase-outs for the student loan interest deduction

EGTRRA also provided increased exemption amounts for the alternative minimum tax (AMT). The increased exemption amounts expired after 2004 but Congress routinely extended them, most recently for 2009. Congress has yet to extend them for 2010 or 2011. Again, the cost of extending them is the stumbling block for many lawmakers.

More temporary incentives

Some temporary tax incentives are almost certain not to be renewed. They include the additional standard deduction for state and local property taxes, the exemption of the first $2,400 in unemployment benefits from federal taxation and COBRA premium assistance.

The fate of the first-time homebuyer credit is also up in the air. The credit was widely popular. Its supporters claim the credit kept the housing market, already at record lows in many parts of the country, from falling even lower. While popular, the credit has been linked to abuse. The IRS reportedly has struggled to correctly process claims for the credit and weed-out fraudulent claims.

Many taxpayers have seen an increase in their take home pay in 2009 and 2010. The Making Work Pay credit provides a refundable tax credit of up to $400 for individuals and up to $800 for married taxpayers filing joint returns. For individuals with income from wages, the credit is typically be handled by their employers through automated withholding changes. The Making Work Pay credit is scheduled to expire after December 31, 2010. President Obama has asked Congress to make the credit permanent but Congress has not acted and is not expected to act before year-end.

There may still be time to take advantage of some valuable energy tax incentives. Homeowners who make energy efficient improvements, such as adding insulation, energy efficient exterior windows and heating and air conditioning, may qualify for a tax credit. The tax credit rate reaches 30 percent of the cost of all qualifying improvements and the maximum credit limit is $1,500 for improvements placed in service in 2009 and 2010. Several energy tax incentives targeted to businesses, while temporary, will not expire until 2012 or later.

Planning questions remain

Uncertainty over the fate of the tax extenders and the other temporary tax incentives leaves many taxpayers in a quandary. Taxpayers can engage in year-end tax planning under the assumption that Congress will renew them or move forward under the assumption that the extenders will not be renewed. Complicating matters even more is the possibility that Congress will renew some of the tax extenders but not all. This is very likely concerning the individual tax extenders, such as the state and local sales tax deduction, the higher education tuition deduction, and the teachers’ classroom expense deduction.

Key developments during the third quarter of 2010

New law gives tax breaks to small business. The Small Business Jobs Act of 2010, which was signed into law on September 27, 2010, includes a number of important tax provisions, including liberalized and expanded expensing for 2010 and 2011, revived bonus depreciation for 2010, five-year carryback of unused general business credits for eligible small businesses, removal of cell phones from the listed property category, and liberalized tax shelter penalty rules.

Schedule UTP for reporting uncertain tax positions finalized and liberalized. The IRS has released a final Schedule UTP (Form 1120), Uncertain Tax Position Statement, and an announcement detailing many liberalizations to the reporting requirements, which initially apply only to large corporations. In addition, the agency has taken steps to protect taxpayer communications with practitioners and to ensure that the program is properly applied by its own personnel. The key changes include: a five-year phase-in of the reporting requirement based on a corporation’s asset size; no reporting of a maximum tax adjustment; no reporting of the rationale and nature of uncertainty in the concise description of the position; and no reporting of administrative practice tax positions.

Guidance addresses tax breaks for hiring new employees. Employers are exempted from paying the employer 6.2% share of Social Security (i.e., OASDI) employment taxes on wages paid in 2010 to newly hired qualified individuals. These are workers who: (1) begin employment with the employer after Feb. 3, 2010 and before Jan. 1, 2011, (2) certify by signed affidavit, under penalties of perjury, that they haven’t been employed for more than 40 hours during the 60-day period ending on the date the individual begins employment with the qualified employer; (3) do not replace other employees of the employer (unless those employees left voluntarily or for cause), and (4) aren’t related to the employer under special definitions. The payroll tax relief applies only for wages paid from Mar. 19, 2010 through Dec. 31, 2010.

Employers also may qualify for an up-to-$1,000 tax credit for retaining qualified individuals. The workers must be employed by the employer for a period of not less than 52 consecutive weeks, and their wages for such employment during the last 26 weeks of the period must equal at least 80% of the wages for the first 26 weeks of the period.

The IRS had issued guidance on these tax breaks in the form of frequently asked questions (FAQs). Updated FAQs explain: when an employee is considered to begin work; how the exemption can be claimed for a new hire who replaces a prior employee; that the exemption can be taken for someone who was self-employed for the entire 60-day lookback period; that minors may sign the HIRE Act employee affidavit (Form W-11); and what counts as wages for the retention credit.

Guidance explains longer NOL carryback option for businesses. The IRS has issued guidance in a question and answer (Q&A) format to address a number of specialized issues that have arisen under the new optional longer net operating loss (NOL) carryback period that was provided by the Worker, Homeownership, and Business Assistance Act of 2009 (WHBAA). Under WHBAA, an irrevocable election of a 3, 4, or 5-year carryback period for an applicable NOL for a tax year ending after Dec. 31, 2007, and beginning before Jan. 1, 2010, is generally available for one tax year (except for an eligible small business (ESB) loss). The WHBAA election is an expansion of the increased carryback period election provided by the American Recovery and Reinvestment Act of 2009 (ARRA), which was available only to ESBs, and only for 2008 NOLs. The guidance addresses many questions left unanswered by the statutory provisions. For example, it makes clear that if a taxpayer previously made an ARRA election, it doesn’t have to continue to qualify as an ESB in the year of the WHBAA NOL in order to make a WHBAA election. A taxpayer must qualify as an ESB only for the tax year of the ARRA election. Also, the IRS has revised the Instructions for Form 1139, Corporation Application for Tentative Refund (Rev. August 2010), to explain how businesses make the WHBAA election.

Regulations on election to defer COD income. For debt discharges in tax years ending after Dec. 31, 2008, a taxpayer may elect to have any cancellation of debt (COD) income from the reacquisition of an applicable debt instrument after Dec. 31, 2008, and before Jan. 1, 2011, included in gross income ratably over five tax years. The IRS has issued two sets of regulations on this rule: one applies to C corporations, the other applies to partnerships and S corporations. The regulations cover many complicated issues that arise with the election. For example, the C corporation regulations cover topics such as acceleration of deferred cancellation of debt (COD) income and deferred original issue discount deductions, and the calculation of earnings and profits as a result of making an election.

Legislation ends foreign loopholes and advance EITC. The Education Jobs and Medicaid Assistance Act, which was signed into law on August 10, 2010, includes provisions closing a number of foreign-tax-credit related loopholes and repealing the advanced earned income tax credit (EITC). Specifically, this legislation tightens the rules on the use of foreign tax credits that multinationals use to lower their U.S. tax bill. In general, these provisions attempt to (1) make foreign tax credits (FTCs) available only when the income to which the FTCs relate is actually taxed by the U.S., (2) prevent artificial inflation of foreign source income, and (3) modify the resourcing rules to limit FTCs. Also, under the new law, starting in 2011, eligible low- and moderate-income workers who qualify for the EITC will no longer be able to elect to receive the credit in advance.

Financial reform package changes mark-to-market rule. The “Restoring American Financial Stability Act of 2010” was signed into law on July, 21, 2010. This landmark financial reform package contained a tax provision broadening the list of contracts that are excepted from mark-to-market treatment. Taxpayers must report gains and losses from regulated futures contracts and other “Section 1256 contracts” on an annual basis under the “mark-to-market” rule. The term Section 1256 contract means: regulated futures contracts, foreign currency contracts, nonequity options, dealer equity options, and dealer securities futures contracts. It does not include any securities futures contract or option on such a contract unless the contract or option is a dealer securities futures contract. Under the new law, for tax years beginning after July 21, 2010, all of the following also are excepted from the definition of a Section 1256 contract: any interest rate swap; currency swap, basis swap, interest rate cap, interest rate floor, commodity swap, equity swap, equity index swap, credit default swap, or similar agreement.

Relief for homeowners with corrosive drywall. The IRS is allowing individuals with corrosive drywall to apply a safe harbor formula to treat the costs of repairing the defective drywall as a casualty loss. The safe harbor applies for original and amended federal income tax returns filed after Sept. 29, 2010. Reported problems have occurred with certain imported drywall installed in homes between 2001 and 2008. Homeowners have reported blackening or corrosion of copper electrical wiring and copper components of household appliances, as well as the presence of sulfur gas odors. In the case of any individual who pays to repair damage to his personal residence or household appliances that results from corrosive drywall, the IRS won’t challenge his treatment of damage resulting from corrosive drywall as a casualty loss (which might otherwise be difficult to achieve under the regular rules) if the loss is determined and reported under the safe harbor rule. A taxpayer who does not have a pending claim for reimbursement may claim as a loss all unreimbursed amounts paid during the tax year to repair damage to his personal residence and household appliances resulting from corrosive drywall. A taxpayer who has a pending claim (or intends to pursue reimbursement) may claim a loss for 75% of the unreimbursed amount paid during the tax year to repair damage to the taxpayer’s personal residence and household appliances that resulted from corrosive drywall.

Over-the-counter drug costs will no longer be reimbursable. Effective Jan. 1, 2011, unless prescribed or insulin, the cost of over-the-counter medicines cannot be reimbursed from flexible spending arrangements (FSA), health reimbursement arrangements (HRA), Health Savings Accounts (HSA) and Archer Medical Savings Accounts (Archer MSA). The IRS has issued guidance explaining that an individual may be reimbursed for over-the counter medicines or drugs, so long as the individual obtains a prescription for the medicines or drugs. It also makes clear that expenses incurred for over-the-counter medicines or drugs purchased without a prescription before Jan. 1, 2011 may be reimbursed tax-free at any time by an employer-provided plan, including an FSA or HRA, under the terms of the employer’s plan.

Simplified per diem rates lowered effective Oct. 1, 2010. Reimbursements of an employee’s business travel costs (lodging, meal and incidental expenses (M&IE)) at a per diem rate are payroll-and income-tax free if simplified substantiation is provided and the daily rate doesn’t exceed the federal per diem rate (the maximum amount that the federal government reimburses its employees) for the locality of travel for that day. While the per diem rates vary by travel destination, employers can make reimbursements at the simplified “high-low” per diem rates, which assign one per diem rate to high-cost areas within the continental U.S., and another to non-high-cost areas. The IRS has issued the “high-low” simplified per diem rates for post-Sept. 30, 2010, travel. An employer may reimburse up to $233 for high-cost localities ($168 for lodging and $65 for M&IE) and $160 for other localities ($108 for lodging and $52 for M&IE). The list of high-cost areas is also updated.

Writing Formal Business Plans

Why Write a Business Plan?

The preparation of a written business plan is not the end-result of the planning process. The realization of that plan is the ultimate goal. However, the writing of the plan is an important intermediate stage – fail to plan can mean plan to fail. For an established business it demonstrates that careful consideration has been given to the business’s development, and for a startup it shows that the entrepreneur has done his or her homework.

Purpose of the Business Plan

A formal business plan is just as important for an established business, irrespective of its size, as it is for a startup. It serves four critical functions as follows:

       1-Helps management or an entrepreneur to clarify, focus and research their business’s or project’s development and prospects.

       2-Provides a considered and logical framework within which a business can develop and pursue business strategies over the next three to five years.

       3-Serves as a basis for discussion with third parties such as shareholders, agencies, banks, investors etc.

       4-Offers a benchmark against which actual performance can be measured and reviewed.

Just as no two businesses are alike, so also with business plans. As some issues in a plan will be more relevant to some businesses than to others, it is important to tailor a plan’s contents to suit individual circumstances. Nonetheless, most plans follow a well-tried and tested structure and general advice on preparing a plan is universally applicable.

A business plan should be a realistic view of the expectations and long-term objectives for an established business or new venture. It provides the framework within which it must operate and, ultimately, succeed or fail. For management or entrepreneurs seeking external support, the plan is the most important sales document that they are ever likely to produce as it could be the key to raising finance etc. Preparation of a comprehensive plan will not guarantee success in raising funds or mobilizing support, but lack of a sound plan will, almost certainly, ensure failure

Importance of the Business Planning Process

Preparing a satisfactory business plan is a painful but essential exercise. The planning process forces managers or entrepreneurs to understand more clearly what they want to achieve, and how and when they can do it. Even if no external support is needed, a business plan can play a vital role in helping to avoid mistakes or recognize hidden opportunities. It is much easier to fold a sheet of paper than a business.

For many, many entrepreneurs and planners, the process of planning (thinking, discussing, researching and analyzing) is just as, or even more, useful than the final plan. So, even if you don’t need a formal plan, think carefully about going through the planning process. It could be enormously beneficial to your business.

Anticipate many weeks of hard work and several drafts of the emerging plan to get the job right. A clearly written and attractively packaged business plan will make it easier to interest possible supporters, investors etc. A well-prepared business plan will demonstrate that the managers or entrepreneurs know the business and that they have thought through its development in terms of products, management, finances, and most importantly, markets and competition.

2. Start with a Business Strategy

A short strategic plan (2-3 pages) can provide a very useful foundation on which to base a much more detailed and comprehensive business plan. If you don’t have a sensible strategic plan, how can you realistically write a sensible business plan? Use a short strategic plan as the foundation for a more comprehensive business plan. See  Building a Strategic Plan

As the prelude to developing a strategic plan, it is desirable to clearly identify the current status, objectives and strategies of an existing business or the latest thinking in respect of a new venture. Correctly defined, these can be used as the basis for a critical examination to probe existing or perceived strengths, weaknesses, threats and opportunities. This then leads to strategy development covering the following issues which are discussed in more detail immediately below:

1.        Vision
2.        Mission
3.        Objectives
4.        Values
5.        Strategies
6.        Goals
7.        Programs

Vision

The first step is to develop a realistic Vision for the business. This should be presented as a pen picture of the business in three or more years time in terms of its likely physical appearance, size, activities etc. Answer the question: “if someone from Mars visited the business, what would they see or sense?”

Mission

The nature of a business is often expressed in terms of its Mission which indicates the purposes of the business, for example, “to design, develop, manufacture and market specific product lines for sale on the basis of certain features to meet the identified needs of specified customer groups via certain distribution channels in particular geographic areas”. A statement along these lines indicates what the business is about and is infinitely clearer than saying, for instance, “we’re in electronics” or worse still, “we are in business to make money” (assuming that the business is not a mint !). Also, some people confuse mission statements with value statements (see below) – the former should be very hard-nosed while the latter can deal with ‘softer’ issues surrounding the business.

Objectives

The third key element is to explicitly state the business’s Objectives in terms of the results it needs/wants to achieve in the medium/long term. Aside from presumably indicating a necessity to achieve regular profits (expressed as return on shareholders’ funds), objectives should relate to the expectations and requirements of all the major stakeholders, including employees, and should reflect the underlying reasons for running the business. 

Values

The next element is to address the Values governing the operation of the business and its conduct or relationships with society, customers, employees etc.

Strategies

Next are the Strategies – the rules and guidelines by which the mission, objectives etc. may be achieved. They can cover the business as a whole including such matters as diversification, organic growth, or acquisition plans, or they can relate to primary matters in key functional areas, for example:

   The company’s internal cash flow will fund all future growth.

   New products will progressively replace existing ones over the next 3 years.

   All assembly work will be contracted out to lower the company’s break-even point.

Goals

Next are Goals. These are specific interim or ultimate time-based measurements to be achieved by implementing strategies in pursuit of the company’s objectives, for example, to achieve sales of $3m in three years time. 

Programs

The final elements are the Programs which set out the implementation plans for the key strategies.

It goes without saying that the mission, objectives, values, strategies and goals must be inter-linked and consistent with each other. This is much easier said than done because many businesses which are set up with the clear objective of making their owners wealthy often lack strategies, realistic goals or concise missions.

Preparatory Business Planning Issues

Before any detailed work commences on writing a comprehensive business plan, you should:

•        Clearly define the target audience
•        Determine its requirements in relation to the contents and levels of detail
•        Map out the plan’s structure (contents page)
•        Decide on the likely length of the plan
•        Identify all the main issues to be addressed.

Shortcomings in the concept and gaps in supporting evidence and proposals need to be clearly identified. This will facilitate an assessment of research to be undertaken before any drafting commences. Bear in mind that a business plan should be the end result of a careful and extensive research and development project which must be completed before any serious writing of a plan should be started. Under no circumstances should you start writing a plan before all the key issues have been crystallized and addressed.

Structure & Content of a Business Plan

A typical business plan comprises the following main elements:

1. Brief Introduction setting out the background and structure of the plan.
2. Summary of a few pages which highlights the main issues and proposals.
3. Main Body containing chapters broken into numbered sections and subsections.
4. Appendices containing tables, detailed information, exhibits, etc. referred to in the text.

Length & Time-scale for Business Planning

Whilst the sheer length of a business plan may bear no relation to the underlying prospects of a business, it is likely that a well-developed plan would be at least twenty pages long plus appendices.

The elapsed time needed to produce a detailed plan might be between twenty and one hundred days. This would be determined not only by the complexity and scale of the venture, but also by the scale and maturity of the business and relevant experience and skills of the management team. Whilst the task of writing the plan itself may only take a relatively short time, be sure to allocate enough time to the research, preparatory work and the underlying thinking and discussion.

For futher reference see:

• http://www.sba.gov/category/navigation-structure/starting-managing-business/starting-business/writing-business-plan
• White paper offering Insights into Business Planning.
• Checklist for Preparing a Business Plan.
• Free-Plan – free 150-page Business Plan Guide and Template (Word format).
• Comprehensive Business Plan

2010 year-end tax planning for individuals presents unique challenges

As the end of 2010 quickly approaches, individual taxpayers should start to execute valuable year-end tax strategies. However, year-end tax planning for 2010 is especially unique, and a bit more complicated, due to the current uncertainty looming over a number of expiring tax cuts.

Several individual tax incentives in the form of deductions, credits, and exemptions, as well as reduced tax rates for long-term capital gains and qualified dividends, are scheduled to expire at the end of 2010. Moreover, the marginal income tax rates for most taxpayers – especially individuals in the top two income tax brackets – are scheduled to rise. The 10 percent tax rate bracket is scheduled to disappear. Another complication to year-end tax planning is the uncertainty caused by the estate and gift tax laws, and their future.

Although many provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) are scheduled to sunset after 2010, the Pension Protection Act of 2006 (PPA) made permanent a host of pension-related provisions, including direct rollovers to Roth IRAs, catch-up contributions to various retirement savings arrangements, and so-called “top-heavy rules” for highly-compensated individuals.

The Obama administration and Congressional Democrats are struggling for a strategy to deal with the soon-to-expire EGTRRA tax cuts, each side uncertain whether the other is up for a fight with Republicans in the wake of the Democrats’ election trouncing — or whether they could win, in any event.

That has both parties betting that the most likely outcomes could be either a truce that extends the tax cuts for all income levels for perhaps a year past their scheduled Dec. 31 expiration, or a stalemate that lets them expire temporarily, in either case delaying the battle until 2011… leaving everyone guessing while attempting to minimize taxes between 2010 and 2011 as to what the 2011 tax rates might be.

Take advantage of lower income tax rates through 2010

As things stand now, however, for 2011 and beyond, the tax rate brackets will be: 15, 28, 31, 36, and 39.6 percent. The 10 percent rate will disappear entirely. Thus, the federal income tax brackets as scheduled for 2011 will result in the following:

2010: 10% 15% 25% 28% 33% 35%

2011:  15% 15% 28% 31% 36% 39.6%

President Obama has proposed to allow the 2001 individual income tax rate reductions to expire for single individuals with incomes exceeding $200,000 and for married couples with incomes exceeding $250,000 and to permanently extend the rate reductions for all other individuals. The president’s proposal would allow the two higher rates to revert to 36 and 39.6 percent, respectively, and provide a higher 28 percent bracket.

In light of the scheduled rate increases, individuals that will be affected by the higher tax rates – particularly higher-income taxpayers falling into the top two brackets – may want to consider opportunities to accelerate taxable income into 2010. Accelerating income into 2010 allows you to take advantage of the current lower tax rates and avoid having some of that income taxed at higher rates next year (as the law currently stands). Although tax considerations should not be the only reason to accelerate income into 2010, if you anticipate that you will fall into a higher tax bracket in 2011 as the law currently stands, you should explore acceleration opportunities.

At the same time as you take advantage of opportunities to accelerate your income into 2010, you may want to defer deductions into 2011 to help ease the impact of the scheduled 2011 increases in the tax rates. Deductions may be more valuable in 2011 when the tax rates will be higher for many individuals and particular higher-income taxpayers. For example, consider postponing charitable giving until 2011, or delay making your mortgage payment until January 1, 2011 or later if your grace period allows.

However, higher-income taxpayers considering deferring deductions until 2011 need to weigh the potential benefit of using these deductions to help offset potentially higher taxable income with the pitfall of the re-emergence of the limit on itemized deductions. The limit on itemized deductions for higher-income taxpayers is completely eliminated for 2010, but effective again in 2011. The limitation threshold amount is generally $100,000 for most taxpayers and $50,000 for married taxpayers filing separately. Thus, if you anticipate being in a higher rate bracket in 2011 you need to carefully weigh the benefits of getting a reduced deduction that offsets income taxed at a higher rate in 2011, against a full deduction that offsets income taxed at a lower rate in 2010.

While accelerating income and deferring deductions are two generally intertwined tax planning strategies, they take on increasing importance in light of the scheduled rates increases. You should talk with your tax advisor about the benefits and pitfalls of using this technique in your particular situation.

Sell investments at lower capital gains rates

The favorable tax rates for capital gains and qualified dividends also continue through December 31, 2010, but will revert to higher levels beginning in 2011. For individuals in the 25 percent or higher income tax brackets, long-term capital gains and qualified dividends are taxed at a maximum rate of 15 percent. For individuals in the 10 and 15 percent brackets, gains are taxed at a generous five percent and zero percent. Unless Congress extends these lower rates, the maximum tax rate on long-term capital gains will increase to 20 percent, and the zero percent rate will be replaced with a 10 percent rate beginning in 2011. Also beginning in 2011, qualified dividends will be taxed at ordinary income tax rates, which could be as high as 39.6 percent.

If you have appreciated investments that you have been considering selling, now may be the time to do so in light of the increased capital gains rates. For higher-income taxpayers this is especially important since the maximum amount of tax on long-term capital gains is 15 percent for 2010, but come 2011 they will be taxed at 20 percent.

Contribute to your retirement plan

Individuals with a traditional IRA or an employer-sponsored retirement plan, such as a 401(k) plan, should consider making a contribution to the plan before year-end, if he or she has not already done so. Making a contribution to a traditional IRA or employer-sponsored retirement plan will reduce your taxable income since funds are contributed before tax. Additionally, you may be able to deduct the contribution on your return.

For 2010, the contribution limit is $5,000 for individuals under age 50 (or $6,000 for individuals older than 50 years of age who qualify for the catch-up contribution). The maximum amount an employee can contribute to a 401(k) in 2010 is $16,500 (and for individuals over the age of 50, their catch-up contribution will remain unchanged at $5,500).

Roth IRA conversions

If you convert your traditional IRA into a Roth in 2010, a special rule allows you to defer paying federal income tax on the conversion income until 2011 and 2012. In lieu of including the conversion income in your 2010 taxable income, you can choose to report half the income in 2011 and half the income in 2012. However, if you make this election, that income will be taxed at the income tax rates in effect in 2011 and 2012, which under current law, is set to be higher for the majority of taxpayers. If you want to convert your traditional IRA into a Roth before the end of the year, you will need to determine whether recognizing all the income in 2010 or spreading it between 2011 and 2012 will garner you a better tax result.

AMT planning

Congress has not enacted an alternative minimum tax (AMT) “patch” for 2010. Be aware, unless Congress enacts an AMT patch retroactive for 2010, the exempt amounts are $33,750 for individuals; $45,000 for married couples filing jointly; and $22,500 for married individuals filing separately. Planning for the AMT is complicated due to Congress’s inaction on passing a patch, unfortunately. Taxpayers should, therefore, begin planning with the 2010 amounts in the alternative.

Estate tax

Unless Congress acts, the federal estate tax is scheduled to revert back to pre- EGTRRA rates for decedents dying after December 31, 2010. The applicable exclusion amount will be $1 million and not $675,000 because of provisions under the Taxpayer Relief Act of 1997 that are not affected by EGTRRA.

Planning opportunities. One consideration may be to mitigate the impact of any estate tax by making tax-free transfers. Under current law, taxpayers may make tax-free gifts of $13,000 per recipient (unlimited in number) for 2010 (and for 2011). Married couples may combine their gift-tax exclusion amounts and make tax-free gifts per recipient of up to $26,000 (again, unlimited in number of recipients) for 2010 (and for 2011).

Education savings

Under EGTRRA, taxpayer-friendly changes to Coverdell Education Savings Accounts (Coverdell ESAs) are scheduled to sunset after 2010. However, EGTRRA’s enhancements to Code Sec. 529 qualified tuition programs were made permanent by the PPA. Taxpayers with unused funds in Coverdell ESAs may want to explore rolling over these amounts into a 529 college savings plan.

A Coverdell Education Savings Account (ESA) is an account created to pay certain qualified education expenses. EGTRRA increased the maximum annual contribution that can be made to a Coverdell ESA from $500 to $2,000, for tax years through December 31, 2010. EGTRRA also expanded the scope of qualified education expenses to include elementary and secondary education expenses, in addition to higher education expenses. However, because of EGTRRA’s sunset rule, the annual contribution limit to a Coverdell ESA reverts to $500 for tax years beginning after December 31, 2010, and distributions from a Coverdell ESA will no longer be allowed to pay elementary and secondary education expenses, apparently irrespective of when the funds were contributed. The modified AGI phaseout range also returns to pre- EGTRRA levels, without inflation adjustment.

529 plans include pre-paid tuition plans established by an eligible education institution or a state; or an investment account established by a state. EGTRRA allowed private educational institutions to establish their own pre-paid tuition plans. EGTRRA also permitted tax-free rollovers of credits or other amounts from one 529 plan to another 529 plan. Additionally, EGTRRA enhanced the limitation on qualified room and board expenses. All of the enhancements to 529 plans were made permanent by the PPA and will not sunset after 2010.

Tax breaks not available in 2010

Certain tax breaks that you may have taken advantage of in 2009, when they were around, are not available this year because they expired December 31, 2009 and have not been extended by Congress. While Congress may act to retroactively extend some, or all, of these incentives for 2010, unless Congress acts, you should be aware that the following tax breaks may not be available for your 2010 tax return:

• The additional standard deduction for state and local property taxes for non-itemizers;
• The deduction for qualified tuition and fees of up to $4,000 for higher education (the higher education expense deduction);
• The deduction of up to $250 in classroom supplies (available to teachers, other educators)
• The election to itemize state and local sales taxes in lieu of state and local income taxes (which mainly benefits individuals in states without state income taxes); and
• The exclusion from gross income of up to $2,400 of unemployment benefits.

Although these, and many other, tax incentives have not been renewed for 2010, taxpayers that have utilized these incentives in the past should include in their year-end tax planning contingencies for both outcomes: you should compute your tentative tax liability under a plan that does not take the applicable incentives into consideration and also compute your liability under a plan that does, in case Congress retroactively extends them.

Conclusion

Despite the complexity caused by the uncertain state of the tax law as of now, individuals can take a number of steps to help minimize their tax liability this year. Depending on your particular situation, you may be able to employ one or more of the planning opportunities discussed above.

2010 year-end tax planning challenges and opportunities for businesses

2010 year-end tax planning involves consideration of tax laws going into effect in 2011 as much as it involves tax provisions effective this year. Some tax incentives that expired for businesses at the end of 2009 have been resurrected for 2010 (and 2011 in some cases), including bonus depreciation and small business expensing. However, with higher tax rates set for 2011, traditional planning techniques, such as acceleration and deferral, may require more thought this year especially. This article explores some planning opportunities, challenges, and issues presented by year-end tax planning for 2010.

Accelerating income/deferring deductions

Every year, businesses can take advantage of a traditional planning technique that involves alternatively deferring income and accelerating deductions. However, business taxpayers such as passthrough entities (limited liability companies, partnerships, S corporations, sole proprietorships) should consider accelerating business income into the current year and deferring deductions until 2011 (and perhaps beyond) in light of the scheduled 2011 tax rate increases (the top two income tax brackets are set to rise from 33 and 35 percent to 36 and 39.6 percent respectively). Since pass-through entities generally pay tax at the individual income tax rate level, and those levels are expected to rise, this may be a significant factor affecting this year’s planning.

For example, limited liability companies, partnerships, and S corporations can avoid or minimize the impact of the scheduled 2011 rate increases by accelerating certain business transactions and thus income into 2010 (and deferring deductions until next year). For instance, if your business is planning to sell certain property, you may want to close the sale in 2010 to avoid the higher 2011 rates. Not only are the ordinary income tax rates scheduled to rise, but too are the capital gains rates. Thus, this strategy can generally help regardless of the type of income generated since rates in both categories are going to rise next year.

The strategy of accelerating income and deferring deductions may apply to a number of transactions affecting your business, including leasing, inventory, compensation and bonus practices, depreciation and expensing. Pass-through entities need to be particularly sensitive to the scheduled 2011 income tax rate increases and therefore plan accordingly.

Cash basis businesses that expect to be in the same or a higher tax bracket in 2011 should consider moves to shift income into 2010 by accelerating cash collections this year, and deferring deductions until next year. Thus, delay payment of certain expenses until next year, where possible, since deductions are allowed when the expenses are actually paid. If you have outstanding accounts receivable, collect on those payments due to your business in 2010.

Accrual method businesses that anticipate being in higher rate brackets next year may want to accelerate the shipment of products or provision of services into 2010 so that your business’s right to the income arises this year.

Take advantage of increased small business expensing

For 2010 and 2011, businesses can benefit from enhanced Code Sec. 179 small business expensing. Congress increased the amount of qualifying property that business that immediately expense to $500,000 (up from $250,000) for tax years beginning in 2010 and 2011. This amount is reduced dollar for dollar to the extent the cost of the qualifying property placed in service during the year exceeds $2 million (increased from $800,000). The increase in the expensing cap from $800,000 to $2 million for 2010 (and 2011) effectively opens up the availability of Code Sec. 179 expensing to many more businesses. If you have bought qualifying property – even computer software qualifies – or plan to buy property, consider doing so now to take advantage of the immediate tax benefit. You can also do so again in 2011, when tax rates are expected to be higher.

Also included in the definition of qualified Code Sec. 179 property (only temporarily though) is qualified real property, which is defined as qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. However, businesses are limited to expensing of up to $250,000 of the total cost of these properties. The dollar cap applies to the aggregate cost of qualified real property.

Bonus deprecation

Bonus depreciation is not limited by the size of the business, unlike practical access to Code Sec. 179 “small business” expensing.  It is valuable because there is no limit on the total amount of bonus depreciation that may be claimed in any given tax year. Bonus depreciation allows taxpayers to immediately deduct 50-percent of the cost of qualifying property purchased and placed in service in 2010. Unlike Sec. 179 expensing, bonus depreciation is only available for 2010. Qualifying property must be purchased and placed into service on or before December 31, 2010.

Before Congress passed the 2010 Small Business Act, 50 percent bonus depreciation applied to property acquired after December 31, 2007, and placed in service before January 1, 2010. Certain property with a longer production period was eligible for an extended placed-in-service deadline before January 1, 2011.

The 2010 Small Business Act extends 50 percent bonus depreciation for qualified property placed in service before January 1, 2011. Bonus depreciation applies to new property (property whose original use begins with the taxpayer) that is depreciable under MACRS and has a recovery period of 20 years or less, is MACRS water utility property, is off-the shelf computer software depreciable over three years under Code Sec. 167(f), or is qualified leasehold improvement property. There is also an extended place-in-service date through December 31, 2011 for property with a longer production period.

Increased start-up expense deduction

New businesses can take advantage of the increased deduction for start-up expenditures. For 2010, the start-up expense deduction limit has been raised from $5,000 to $10,000. The phaseout threshold is also increased to $60,000 (up from $50,000). Thus, if you have incurred during 2010 costs relating to the creation of an active trade or business, or the investigation of the creation or acquisition of an active trade or business, you may be able to benefit from this increased deduction. Entrepreneurs can recover more small business tart-up expenses up-front, thereby increasing cash flow and providing other benefits.

Payroll tax exemption

Employers that hire certain unemployed individuals after February 3, 2010, and before January 1, 2011 may qualify for a 6.2-percent payroll tax incentive. The incentive exempts businesses from paying the employer’s share of Social Security taxes on wages paid to qualified new hires after March 18, 2010 and before January 1, 2011. Some employers mistakenly believe that they cannot claim the incentive unless they had previously laid off employees. This is incorrect. The payroll tax exemption can apply to wages paid to any qualified employee.

Not every new hire may qualify for the incentive. Generally, a qualified employee is an individual who was unemployed or who was employed but worked 40 hours or less during the 60-day period ending on the date of new employment. The individual also must not have been hired to replace another employee of that employer, unless the other employee separated from employment voluntarily or was terminated for cause. Certain family members of the employer or employees who are related in other ways to the employer are not qualified employees for purposes of the payroll tax exemption.

Worker retention credit

Related to the payroll tax exemption is a new but temporary worker retention credit. An eligible employer may claim the credit for each new hire who meets certain retention requirements. A retained worker is a qualified employee (as defined for purposes of the payroll tax exemption) who remains an employee for at least 52 consecutive weeks, and whose wages (as defined for income tax withholding purposes) for the last 26 weeks equal at least 80 percent of the wages for the first 26 weeks. The amount of the credit is the lesser of $1,000 or 6.2 percent of wages (as defined for income tax withholding purposes) paid by the employer to the retained worker during the 52 consecutive week period. The credit may be claimed for a retained worker for the first taxable year ending after March 18, 2010 for which the retained worker satisfies the 52 consecutive week requirement.

Code Sec. 199 deduction

Often overlooked is the Code Sec. 199 domestic production activities deduction. The deduction is targeted to U.S. taxpayers engaged in manufacturing activities. The definition of manufacturing is broad for purposes of the deduction but its under-utilization may be due to the complexity surrounding the deduction. Generally, the maximum Code Sec. 199 deduction is equal to a percentage of the lesser of either the taxpayer’s qualified production activities income (QPAI) or taxable income. The maximum deduction for 2010 is, for most taxpayers, nine percent. The deduction is, however, limited to 50 percent of the W-2 wages actually paid to employees and reported by the employer. Additionally, certain businesses, such as oil producers, must reduce their Code Sec. 199 deduction.

Code Sec. 45R credit

Small employers offering qualified health insurance coverage to their employees may be eligible for a new tax credit. The Code Sec. 45R credit is generally available to small employers that pay at least half the cost of qualified coverage. For the 2010 tax year, the maximum credit is 35 percent of premiums paid by eligible employers (nonprofit employers may be eligible for a reduced credit of 25 percent). The maximum credit goes to employers with 10 or fewer full-time equivalent (FTE) employees paying average annual wages of $25,000 or less. The credit is completely phased out for employers with more than 25 FTEs or with average annual wages of more than $50,000.

The Code Sec. 45R credit has many restrictions. For example, many small businesses may employ family members of the owner(s). Certain family members are excluded from the definition of employee for purposes of the Code Sec. 45R credit. A sole proprietor, a partner in a partnership, a shareholder owning more than two percent of an S corporation, and any owner of more than five percent of other businesses also are not considered employees for purposes of the credit.

General business credit

The 2010 Small Business Act made some taxpayer-friendly changes to the Code Sec. 38 general business credit. The eligible small business credits of an eligible small business (ESB) determined in the first tax year of the business that begins in 2010 may be carried back five years and forward for 20 years. An ESB is a corporation the stock of which is not publicly traded; a partnership; or a sole proprietorship (Code Sec. 38(c)(5)(C), as added by the 2010 Jobs Act). Additionally, the ESB must have average annual gross receipts for the three-tax-year period before the tax year of $50 million or less. The provision is intended to encourage ESBs to accelerate their business expenditures to 2010.

Energy tax incentives

A variety of tax incentives are available to encourage businesses to invest in energy conservation, energy efficiency and the production of alternative energy. Taxpayers generally have through December 31, 2013 to place in service biomass, marine and other types of renewable energy property to claim the renewable energy production tax credit (although the placed in service date for wind facilities is through December 31, 2012). Additionally, taxpayers that place in service qualified renewable energy property may elect to claim the investment tax credit in lieu of the production tax credit. Taxpayers may also be eligible to apply for a grant instead of claiming the investment tax credit or the renewable energy production tax credit for property placed in service in 2010.

Additional planning techniques

There are a number of other year-end tax planning strategies you may want to consider utilizing for 2010. These include potentially changing your accounting method to advance income or defer expenses (however, accounting method changes can have a binding elect on taxpayers for future years); accelerating installment sale proceeds or electing out of the installment method; electing slower depreciation methods, deferring payments of accrued bonuses; and determine if you can write-off any bad debts.

Year-end planning: Last minute tips for individuals

With the end of the 2010 tax year rapidly approaching, there is only a limited amount of time for individuals to take advantage of certain tax savings techniques. This article highlights some last-minute tax planning tips before the end of the year.

Make a charitable contribution by cash or credit card. Charitable contributions can be made at any time, in cash or in property. Taxpayers may also want to accelerate dues and fees for church or synagogue memberships. While a pledge is not deductible, an actual payment will qualify when the payment is made, not when it is received. Thus, putting a check in the mail qualifies as a payment when the payer gives up control of the check (assuming there are sufficient funds and the check is eventually honored), not when the check is received, deposited, or honored.

Charging a contribution is another means of accelerating payment. Payment by credit card is in effect a loan to the payer and is deductible when the charge is made, not when the bill is paid or the charge is honored. Thus, if you make the charge in 2010 but it is not honored until 2011, you can still take the charitable deduction on your 2010 return. Payment by debit card again is a payment when the transaction occurs, even if the amount is not debited until the following day.

Note: special rules may apply to contributions of property, especially motor vehicles.

Adjust withholding. State and local income taxes are deductible when withheld, paid as estimated taxes or paid with a return. If you anticipate owing taxes for 2010, you can increase withholding or make an additional payment to cover the expected liability. The payment must be made in good faith and be based on a reasonable estimate of your tax liability. Taxpayers paying estimated taxes can make the final payment before the end of 2010.

Itemized deductions. In past years, there have been limits on itemized deductions taken by higher-income taxpayers. These limits do not apply in 2010, so taxpayers should not feel constrained to limit their payments and contributions. For higher-income taxpayers, this is especially beneficial.

Deduction for health insurance costs. If you are self-employed, you can take a deduction for your health insurance costs when computing self-employment tax and the self-employment tax deduction.

Small business stock. If you sell qualified small business stock before January 1, 2011, and are eligible for the increased exclusion from income, you may be able to exclude 100 percent of the gains from the sale of stock. Speak with your tax professional before selling such stock, however, since the rules on eligibility and holding periods can be complex. For a majority of taxpayers, the traditional rules for accelerating/deferring income and/or maximizing or deferring deductions to lower your tax bill may still apply in 2010, despite the threat of higher income tax rates next year still possible. Depending on your situation, you may want to:

- Accelerate income if possible, including bonuses, into 2010;
- Defer selling capital assets at a loss until 2011 and later years;
- Sell capital assets that have appreciated in 2010 to take advantage of the lower capital gains rates (the maximum capital gains rate is 15 percent for 2010);
- Move some assets into tax-free instruments, like municipal bonds, that are not subject to federal tax;
- Accelerate billings and/or provide incentives for clients or customers to make payments in 2010 (if you are a self-employed and/or cash-basis taxpayer);
- Take taxable retirement plan distributions before 2011 (for taxpayers over age 59 1/2); and
- Bunch itemized or business deductions into the 2011 tax year.

Maximize “above-the-line” deductions. Above-the-line deductions are especially valuable because they reduce your adjusted gross income (AGI). Many tax benefits may be limited for taxpayers whose AGI is too high. Common above-the-line deductions include contributions to traditional Individual Retirement Account (IRA) and Health Savings Account (HSA), moving expenses, self-employed health insurance costs, and alimony payments.

Claim “green” credits. You may be able to claim tax credits for purchasing particular property. Certain hybrid cars, such as the Nissan Altima, qualify for an energy credit under Code Sec. 30B. It may be necessary to consult with an auto dealer or check IRS rulings to see what credits are in effect, because the credit for a qualifying “green” vehicle phases out over time and eventually is reduced to zero.

Another credit available for “green” taxpayers is the residential energy credit. The credit is 30 percent, up to a total of $1,500, of certain energy-efficient improvements made by a homeowner to his or her principal residence during 2009 and 2010. For example, the credit can be claimed by installing energy efficient windows and doors.

Make a tax-free gift. You can gift, tax-free, up to $13,000 per donee in 2010. A married couple can apply a combined exclusion of $26,000 to a gift of property for one person. Further amounts to any one taxpayer will be offset by the donor’s lifetime exclusion before gift tax is owed. The exclusion applies per year. If it is not used, it is lost; it does not carry over to the succeeding year.

Use an installment sale. If you may be selling property at a gain, you can avoid recognizing the entire gain by using an installment sale. An installment sale has at least one payment after the year of sale. The payment is taxed when it is made, not at the time of the sale. Thus, income can be postponed. The installment method is not available for stocks and bonds, however.

There can be competing considerations, however. Tax rates may increase in 2011 and future years, although perhaps only for the highest-income taxpayers. Still, the amount of gain included in a future payment could be taxed at a higher rate. The 3.8 percent Medicare tax imposed on certain income starting in 2013 also is a factor.

Take your required minimum distributions (RMDs). RMDs have returned for 2010. Although Congress temporarily suspended the RMD requirements for distributions from IRAs and other retirement accounts in 2009, it did not extend this benefit into 2010. Therefore, taxpayers who are age 70 or older must take their RMD from a traditional IRA (Roth IRAs are not subject to the RMD rules), 401(k) or other retirement accounts by December 31. Failure to do so will subject you to a stiff penalty of 50 percent of the amount you were required to withdraw but failed to. However, for taxpayers who turned age 70 in 2010, you have until April 1, 2011 to take your first RMD.

2010 Tax Relief Act: A General Overview

After weeks of intense negotiations between the White House and Congressional leaders, Congress passed and President Obama signed into law a two-year extension of soon-to-have-expired  Bush-era tax cuts, including extension of current individual tax rates and capital gains/dividend tax rates. Called the most sweeping tax law in a decade, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (H.R. 4853), was approved by the Senate on December 15, 2010 and by the House on December 16, 2010.  The new law is, however, much more than just an extension of existing tax rates. The new law also provides a temporary across-the-board payroll tax cut for wage earners, a retroactive AMT “patch,” estate tax relief, education and energy incentives and many valuable incentives for businesses, including 100 percent bonus depreciation and extension of many temporary tax breaks. This post highlights many of the key incentives in the new law.

Individuals

Tax rates. Among the most valuable tax breaks for individuals in the new law are a two-year extension of individual income tax rate reductions and a payroll tax cut.  Both will deliver immediate tax savings starting in January 2011.  The new law keeps in place the current 10, 15, 25, 28, 33, and 35 percent individual tax rates for two years, through December 31, 2012. If Congress had not passed this extension, the individual tax rates would have jumped significantly for all income levels.  The new law also extends full repeal of the limitation on itemized deductions and the personal exemption phaseout for two years. Married couples filing jointly will also benefit from extended provisions designed to ameliorate the so-called marriage penalty.

Payroll tax cut. The payroll tax cut is designed to get more money into workers’ paychecks and to encourage consumer spending. Effective for calendar year 2011, the employee share of the OASDI portion of Social Security taxes is reduced from 6.2 percent to 4.2 percent up to the taxable wage base of $106,800. Self-employed individuals also benefit. Self-employed individuals will pay 10.4 percent on self-employment income up to the wage base (reduced from the normal 12.4 percent rate).  The payroll cut replaces the Making Work Pay credit, which reduced income tax withholding for wage earners in 2009 and 2010. The payroll tax cut, unlike the credit, does not exclude some individuals based on their earnings and has the potential of significantly higher benefits (with a maximum payroll tax reduction of $2,136 on wages at or above the $106,800 level as compared to a maximum available $800 Making Work Pay credit for married couples filing jointly ($400 for single individuals)).  

Capital gains/dividends. The new law also extends reduced capital gains and dividend tax rates.  Like the individual rate cuts, the extended capital gains and dividend tax rates are temporary and will expire after 2012 unless Congress intervenes.  In the meantime, however, for two years (2011 and 2012), individuals in the 10 and 15 percent rate brackets can take advantage of a zero percent capital gains and dividend tax rate.  Individuals in higher rate brackets will enjoy a maximum tax rate of 15 percent on capital gains, as opposed to a 20 percent rate that had been scheduled to replace it and with dividends taxed at income tax rates.  Only net capital gains and qualified dividends are eligible for this special tax treatment. If you have any questions about your capital gain/dividend income, please contact our office.

AMT patch. More and more individuals are finding themselves falling under the alternative minimum tax (AMT) because of the way the AMT is structured. To prevent the AMT from encroaching on middle income taxpayers, Congress has routinely enacted so-called “AMT patches.”  The new law continues this trend by providing higher exemption amounts and other targeted relief.

More incentives. Along with all these incentives, the new law extends many popular but temporary tax breaks. Extended for 2011 and 2012 are:

       $1,000 child tax credit

       Enhanced earned income tax credit

       Adoption credit with modifications

       Dependent care credit

       Deduction for certain mortgage insurance premiums

The new law also extends retroactively some other valuable tax incentives for individuals that expired at the end of 2009. These incentives are extended for 2010 and 2011 and include:

       State and local sales tax deduction

       Teacher’s classroom expense deduction

       Charitable contributions of IRA proceeds

       Charitable contributions of appreciated property for conservation purposes

Businesses

Bonus depreciation. Bonus depreciation is intended to help businesses depreciate purchases faster against their taxable income, thereby encouraging businesses to invest in more equipment. Bonus depreciation allows businesses to recover the costs of certain capital expenditures more quickly than under ordinary tax depreciation schedules.  Businesses can use bonus depreciation to immediately write off a percentage of the cost of depreciable property.  The new law makes 100 percent bonus depreciation available for qualified investments made after September 8, 2010 and before January 1, 2012. It also continues bonus depreciation, albeit at 50 percent, on property placed in service after December 31, 2011 and before January 1, 2013. There are special rules for certain longer-lived and transportation property. Additionally, certain taxpayers may claim refundable credits in lieu of bonus depreciation. 100 percent bonus depreciation is a valuable tax break and businesses have only a short window to take advantage of it. Please contact our office so we can help you plan for 100 bonus depreciation.

Code Sec. 179 expensing. Along with bonus depreciation, the new law also provides for enhanced Code Sec. 179 expensing for 2012. Under current law, the Code Sec. 179 dollar and investment limits are $500,000 and $2 million, respectively, for tax years beginning in 2010 and 2011. The new law provides for a $125,000 dollar limit (indexed for inflation) and a $500,000 investment limit (indexed for inflation) for tax years beginning in 2012 (but not after).

Research credit. Many businesses urged Congress to make the research credit permanent after the credit expired at the end of 2009. While this proposal enjoyed significant support in Congress, its cost was deemed prohibitive. Instead, Congress extended the research tax credit for two years, for 2010 and 2011.

More incentives. Other valuable business incentives in the new law include extensions of:

       100 percent exclusion of gain from qualified small business stock

       Transit benefits parity

       Work Opportunity Tax Credit (with modifications)

       New Markets Tax Credit (with modifications)

       Differential wage credit

       Brownfields remediation

       Active financing exception/look-through treatment for CFCs

       Tax incentives for empowerment zones

       Special rules for charitable deductions by corporations and other businesses

       And more

Energy

In 2010, Congress had been expected to pass comprehensive energy legislation including new and enhanced tax incentives. For a number of reasons, an energy bill did not pass. However, the new law extends some energy tax breaks for businesses. The new law also extends, but modifies, a popular energy tax break for individuals.

Businesses. For businesses, one of the most valuable energy incentives is the Code Sec. 1603 cash grant in lieu of a tax credit program. This incentive encourages the development of alternative energy sources, such as wind energy. Other business energy incentives extended by the new law include excise tax and other credits for alternative fuels, percentage depletion for oil and gas from marginal wells, and other targeted incentives.

Individuals. Individuals who made energy efficiency improvements to their homes in 2009 or 2010 are likely familiar with the Code Sec. 25C energy tax credit.  This credit rewards individuals who install energy efficient furnaces or add insulation, or make other improvements to reduce energy usage. The new law extends the credit through 2011 but reduces some of its benefits. Although 2010 is soon over, there may still be time to take advantage of the more generous credit. Please contact our office.

Education

The Tax Code includes a number of incentives to encourage individuals to save for education expenses. In 2009, Congress enhanced the Hope education credit and renamed it the American Opportunity Tax Credit (AOTC). Like many other incentives, the AOTC was temporary. The new law extends it for two years, through 2012. Along with the AOTC, the new law also extends:

       Higher education tuition deduction

       Student loan interest deduction

       Exclusion for employer-provided educational assistance

       Enhanced Coverdell education savings accounts

       Special rules for certain scholarships 

Estate and gift taxes

The federal estate tax, along with federal gift and generation skipping transfer (GST) taxes, was significantly overhauled in 2001. At that time, Congress set in motion a gradual reduction of the estate tax until abolishing it for 2010. Under budget rules, however, those changes could extend for only 10 years; starting in 2011, the estate tax had been scheduled to revert to its pre-2001 levels of 55 percent and a $1 million exclusion.

Estate tax. The new law revives the estate tax, but with a maximum estate tax rate of 35 percent with a $5 million exclusion. The revived estate tax is in place for decedents dying in 2011 and 2012. The new law gives estates the option to elect to apply the estate tax at the 35 percent/$5 million levels for 2010 or to apply carryover basis for 2010. The new law also allows “portability” between spouses of the maximum exclusion and extends some other taxpayer-friendly provisions originally enacted in 2001.

This far-reaching multi-billion dollar tax package affects almost every taxpayer. Keep in mind that many of its provisions are temporary. It is important to plan early to maximize your tax savings.

Many taxpayers will not be able to file early this year.

Update as of 1/21/2011:

The IRS announces they will start processing delayed returns on Feb. 14, giving a different emphasis to the Valentine’s holiday this year.

Although individual income tax returns don’t have to be filed until April 15, (extended to April 18 this year) taxpayers who file early get their refunds a lot sooner. The IRS normally begins accepting returns in January but does not starting processing returns until February.

However, taxpayers affected by three recently reinstated deductions and those who itemize deductions on Form 1040 Schedule A have to wait until mid- to late February to file their 2010 federal income tax returns. The filing delay is due to late tax law changes that affected set-up of IRS processing systems.

Taxpayers claiming any of these three items — involving the state and local sales tax deduction, higher education tuition and fees deduction and educator expenses deduction as well as those taxpayers who itemize deductions on Form 1040 Schedule A — will need to wait to file their tax returns.

Affected taxpayers fall into three categories:

Taxpayers claiming itemized deductions on Schedule A
Itemized deductions include mortgage interest, charitable deductions, medical and dental expenses as well as state and local taxes. In addition, itemized deductions include the state and local general sales tax deduction extended in the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 enacted Dec. 17. This primarily benefits people living in areas without state and local income taxes and is claimed on Schedule A, Line 5. Because of late Congressional action to enact tax law changes, anyone who itemizes and files a Schedule A will need to wait to file until mid- to late February.

Taxpayers claiming the Higher Education Tuition and Fees Deduction
This deduction for parents and students — covering up to $4,000 of tuition and fees paid to a post-secondary institution — is claimed on Form 8917. However, the IRS emphasized that there will be no delays for millions of parents and students who claim other education credits, including the American Opportunity Tax Credit and Lifetime Learning Credit.   

Taxpayers claiming the Educator Expense Deduction
This deduction is for kindergarten through grade 12 educators with out-of-pocket classroom expenses of up to $250. The educator expense deduction is claimed on Form 1040, Line 23, and Form 1040A, Line 16.

The IRS will release a specific date in the near future when it can start processing tax returns affected by the late tax law changes. Until then, affected taxpayers cannot submit their returns until IRS systems are ready to process the new tax law changes.

Provisions NOT extended by the 2010 Tax Relief Act

While the 2010 Tax Relief Act extends a number of tax breaks that were scheduled to expire in 2009 or 2010, it is important to know which expired 2009/2010 provisions were not extended by the 2010 Tax Relief Act or other Acts. Here is a listing of selected non-extended provisions affecting individuals and small businesses.  Listed first are provisions that expired in 2009, and then provisions that expired in 2010. For each expired provision, the consequence(s) of the failure to extend the provision is indicated, as well.

Expiring in 2009

1. Work opportunity tax credit with respect to certain individuals affected by Hurricane Katrina for employers inside disaster areas – The credit doesn’t apply to “Hurricane Katrina employees” hired after Aug. 27, 2009.
2. Alternative motor vehicle credit for qualified hybrid motor vehicles other than passenger automobiles and light trucks – The credit has expired, effective for purchases after Dec. 31, 2009.
3. Additional standard deduction for State and local real property taxes – For tax years beginning after Dec. 31, 2009, the real property tax standard deduction isn’t in effect.
4. Exclusion of unemployment compensation benefits from gross income - For tax years beginning after Dec. 31, 2009, the partial exclusion for unemployment benefits isn’t in effect.
5. Deduction for State sales tax and excise tax on the purchase of motor vehicles – Effective for purchases after Dec. 31, 2009, the deduction is no longer in effect.
6. $500 per-casualty floor on deduction for casualty and theft losses – For tax years beginning after 2009, the per-casualty floor is $100.
7. Waiver of 10%-of-AGI limit on personal casualty losses for “federally declared disasters” in 2008 and 2009 – The exception to the 10%-of-AGI limitation for disaster losses doesn’t apply to federally declared disasters occurring after Dec. 31, 2009.
8. Five-year depreciation for farming business machinery and equipment – Most machinery and equipment used in a farming business and placed in service after Dec. 31, 2009, is 7-year recovery property.
9. Special depreciation allowance for qualified disaster property – This provision doesn’t apply to property placed in service in a disaster area with respect to a federally declared disaster occurring after Dec. 31, 2009.
10. Extended net operating loss (“NOL”) carryback period – The election to extend the standard two-year loss carryback period for an additional period of up to three years expired effective for NOLs arising in a tax year beginning after Dec. 31, 2009.
11. Five-year carryback of NOLs attributable to pre-2010 federally declared disasters – The normal two-year carryback period applies to NOLs attributable to post-2010 federally declared disasters.
12. Allowance of additional IRA contributions in certain bankruptcy cases – For tax years beginning after Dec. 31, 2009, the additional contribution provision doesn’t apply.
13. Waiver of minimum required distribution rules for IRAs and defined contribution plans – The required minimum distribution rules are back in effect.
14. Treatment of certain transfers in trust as taxable gifts under section 2503 – The rule treating any post-2009 transfer to a non-grantor trust as a gift was scheduled to expire on Dec. 31, 2010, but the 2010 Tax Relief Act retroactively repealed the rule.
15. Use of single-employer defined benefit plan’s prior-year adjusted funding target attainment percentage to determine application of limitation on benefit accruals – The temporary relief rule expired December 31, 2009.

Expiring in 2010

1. First-time homebuyer credit – Purchases after April 30, 2010, don’t qualify for the credit, but buyers who entered into written contracts by that date had until Sept. 30, 2010, to close on the purchase. In addition, extended deadlines apply to individuals serving on official extended duty outside the U.S.
2. Sixty-five percent subsidy for payment of COBRA health care coverage continuation premiums – The COBRA premium reduction is not available for individuals who are involuntarily terminated after May 31, 2010. Individuals who qualified on or before May 31, 2010, may continue to pay reduced premiums for up to 15 months, as long as they are not eligible for another group health plan or Medicare.
3. Alternative motor vehicle credit for qualified alternative fuel vehicles – The credit isn’t available for property purchased after Dec. 31, 2010.
4. Making work pay credit – The credit, which was allowed for 2009 and 2010, isn’t available for tax years beginning after Dec. 31, 2010.
5. Eligible small businesses allowed to offset AMT liability with general business credits – For tax years beginning after 2010, the provision allowing eligible small businesses to offset AMT liability with general business credits is not in effect.
6. 5-year carryback of eligible small business credits – For tax years beginning after 2010, the carryback period reverts to one year (down from the 5-year carryback period allowed for eligible small business credits determined in tax years beginning in 2010).
7. Work opportunity tax credit targeted group status for unemployed veterans and disconnected youth – Unemployed veterans and disconnected youth who begin work for the employer after 2010 are not treated as members of a targeted group.
8. Modification of AMT limitations on tax-exempt bonds – Tax-exempt interest on private activity bonds issued after Dec. 31, 2010, is an item of tax preference for AMT purposes.
9. Deferral and ratable inclusion of income from business debt discharged by reacquisition – The provision allowing debt discharge income from reacquisitions of business debt at a discount in 2009 and 2010 to be deferred for up to five years doesn’t apply to discharges after Dec. 31, 2010.
10. Deduction of health insurance costs in computing self-employment tax – For tax years beginning after 2010, health insurance costs for self and family are not deductible in computing self-employment tax.
11. Enhanced deduction limit and phaseout for startup costs – For tax years beginning after 2010, the maximum deduction for start-up expenditures is $5,000 (down from $10,000 in 2010), and the deduction phaseout threshold is $50,000 (down from $60,000 in 2010).
12. Computer technology and equipment allowed as a qualified higher education expense for section 529 accounts – For expenses paid or incurred after 2010, computer technology and equipment is not allowed as a qualified higher education expense for section 529 accounts.
13. Modified carryover basis rules for property acquired from a decedent who dies during 2010 – The modified carryover basis rules for property acquired from a decedent who dies in 2010 was repealed by the 2010 Tax Relief Act, but the executor can elect out of the estate tax and into the modified carryover basis rules for deaths in 2010.
14. Temporary repeal of the estate and generation-skipping transfer taxes – The 2010 Tax Relief Act reinstated the estate and generation-skipping transfer taxes for decedents dying, and transfers made, after Dec. 31, 2009.
15. Advance payment of the earned income tax credit (EITC) – For tax years beginning after 2010, advance payment of the EITC is eliminated.

It’s the Slight Edge of the Right Strategic Planning and Execution Rhythm that Creates Success in a Recovering Economy!

By guest blogger - Jon L. Iveson, Ph.D.

We are 30 days into the New Year and several months into a recovering economy.  It is a good time to assess and evaluate our situation.  

It seems that that recovering economy has taken hold and a double dip recession is extremely unlikely.  Also, the typical excitement and enthusiasm about the New Year has waned so we can now better understand the brutal facts of what is needed for success in this recovering economy.

As I work with my on-going clients and interact with new prospects and leads, I see one glaring difference.  My clients have a SLIGHT EDGE over these prospects and leads I run into these days – they are working the right strategic planning and execution rhythm that creates success and momentum in a recovering economy!

This slight edge comes from well thought out 90-day plans that align with a well thought out strategic direction.  They also have a pulsing energy around priorities and dialogues that give them a 10% to 25% edge in creating and capitalizing on opportunities.

This aligns with what Jeff Olson said about planning in his book, The Slight Edge:

“You have to start with a plan, but the plan you start with will not be the plan that gets you there…And that the reason you need a plan: if you have no plan, there will be no jumping off.  In fact, if you put too much energy into the plan, and make it too perfect, you’re more likely to squelch all the life, spontaneity, intuition, and joy out of the doing of it.”

I still see many companies and executives waiting for the right time to create this advantage.  They don’t have a good process for creating their quarterly “plans to start” and they don’t have a strong dynamic for facilitating spontaneity, intuition, and joy in executing those plans.

These companies and executives are costing themselves a 10% to 25% edge in creating and capitalizing on opportunities each month in this recovering economy.  That makes a real difference over the course of the year!

Think about it!

If you had another 10% to 25% edge in creating and capitalizing on opportunities each month and thus were able to generate real results on just 25% of those opportunities during the course of the year, could that be the difference between SUCCESS and FAILURE in this recovering economy?  In other words, would three BIG wins (whatever they turn out to be) make a difference in your success this year?

© Copyright 2011 Jon L. Iveson, Ph.D.

Jon L. Iveson, Ph.D. is a Gazelles Certified Business Coach who specializes in helping companies and executives thrive.  To learn more about him, please visit his website at www.learningtobeachampion.com or contact Jon at (877)342-4267 or jiveson@learningtobeachampion.com

Payroll tax cut in the 2010 Tax Relief Act

The biggest new tax break for individuals in the recently enacted “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” is the one-year payroll tax reduction. Under this new provision, which is intended to supplement income and boost economic growth, the payroll tax—which funds Social Security—has been cut by two percentage points for 2011. Here are the details:

• The Social Security payroll tax on individual wages has been lowered to 4.2% in 2011, from the usual 6.2% rate. For an individual with wages of $60,000, that amounts to a $1,200 savings for individuals with an income of $60,000. If the individual gets paid twice a month, it will mean an extra $50 in his or her paycheck starting in January.
• Self-employed workers will also get the tax break. Their self-employment taxes will be cut from 12.4% to 10.4%.
• There is no phaseout (i.e., gradual reduction) of the payroll tax reduction for higher income workers. It goes to everyone who works, regardless of income. However, since Social Security taxes apply only to the first $106,800 in earnings in 2011, the benefit for high earners tops out at $2,136.
• The payroll tax reduction in effect replaces the $400-per-worker tax break included in the 2009 stimulus bill. That break, called the Making Work Pay tax credit, provided a tax credit of 6.2% on the first $6,450 of a workers’s wages but was phased out for workers making more than $75,000 ($150,000 for couples). The Making Work Pay credit, which was billed as a way to stimulate the stalled economy, is widely though to have had little if any success in that regard, in part because of the small amounts involved—$400 for individuals, $800 for couples. The new law’s payroll tax reduction, by contrast, provides a potentially much bigger tax break for taxpayers (up to $2,136 for individuals, $4,272 for couples). In addition, the benefits of the payroll tax reduction are distributed far differently than they were under the Making Work Pay credit, which was aimed primarily at low and moderate-income workers. For example, an individual making $100,000 in 2011 will be able to keep an extra $2,000 under the payroll tax reduction, but under the Making Work Pay credit (which was phased out for earnings over $75,000), the individuals’s tax break would have been zero.
• The employer’s share of Social Security tax is not affected; it stays at 6.2%. Thus, the cost of hiring new workers isn’t directly affected by the payroll tax reduction.
• The tax break only applies for one year, 2011—for now anyway. There will almost certainly be efforts to extend it beyond 2011, and I will keep you apprised of any developments in that regard.
• The payroll tax reduction will cost the government an estimated $120 billion.
• The payroll tax reduction will not affect the worker’s future Social Security benefit, because benefits are based on lifetime earnings, not the amount of tax paid by the worker into the Social Security system.

Tax aspects of caring for an elderly individual

Here are some of the tax aspects of taking on the care of an elderly or incapacitated individual that may help offset the high costs of long-term care.

1. Dependency exemption. You may be able to claim the cared-for individual as your dependent, thus qualifying for an exemption. To qualify, (a) you must provide more than 50% of the individual’s support costs, (b) he must either live with you or be related, (c) he must not have gross income in excess of the exemption amount, which is $3,700 for 2011 ($3,650 for 2010), (d) he must not himself file a joint return for the year, and (e) he must be a U.S. citizen or a resident of the U.S., Canada, or Mexico. If the support test ((a), above) can only be met by a group (several children, for example, combining to support a parent), a “multiple support” form can be filed to grant one of the group the exemption, subject to certain conditions.

2. Medical expenses. If the individual qualifies as your dependent, you can include any medical expenses you incur for him along with your own when determining your medical deduction. If he doesn’t qualify as your dependent only because of the gross income or joint return test ((c) and (d), above), you can still include these medical costs with your own. The costs of qualified long-term care services required by a chronically ill individual and eligible long-term care insurance premiums are included in the definition of deductible medical expenses. There’s an annual cap on the amount of premiums that can be deducted. The cap is based on age, going as high as $4,240 for 2011 ($4,110 for 2010) for an individual over 70.

3. Filing status. If you aren’t married, you may qualify for “head of household” status by virtue of the individual you’re caring for. If the person you’re caring for (a) lives in your household, (b) you cover more than half the household costs, (c) he qualifies as your dependent, and (d) he is a relative, you can claim head of household filing status. If the person you’re caring for is your parent, he need not live with you, as long as you provide more than half of his household costs and he qualifies as your dependent.

4. Dependent care credit. If the cared-for individual qualifies as your dependent, lives with you, and physically or mentally cannot take care of himself, you may qualify for the dependent care credit for costs you incur for his care to enable you and your spouse to go to work.

5. Exclusion for payments under life insurance contracts. Any lifetime payments received under a life insurance contract on the life of a person who is either terminally or chronically ill are excluded from gross income. A similar exclusion applies to the sale or assignment of a life insurance contract to a person who regularly buys or takes assignments of such contracts and meets other qualifying standards.

Key developments during the fourth quarter of 2010

While the new law tax changes in the bipartisan legislation that was enacted in late 2010 were the most significant developments in the fourth quarter of 2010, many other tax developments may affect you, your family, and your livelihood. These other key developments in the fourth quarter of 2010 are summarized below. Please contact us for more information about any of these developments and what steps you should implement to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

Final regulations on stock reporting rules. The IRS has issued final regulations explaining the complex basis and character reporting requirements that apply for most stock acquired after 2010, for shares in a regulated investment company (i.e., a mutual fund) or stock acquired in connection with a dividend reinvestment plan after 2011, and for other specified securities acquired after 2012. In brief, brokers will have to report to the IRS the customer’s adjusted basis (cost for tax purposes) in the security and whether any gain or loss is short- or long-term. When these rules are fully implemented, the IRS will be in a much better position to monitor whether taxpayers are properly reporting investment gains and losses.

More guidance on the small business health care credit. The IRS issued a second wave of detailed guidance on the small employer health insurance credit created by last year’s health reform legislation. For tax years beginning after Dec. 31, 2009, an eligible small employer (ESE) may claim a tax credit for nonelective contributions to purchase health insurance for its employees. An ESE is an employer with no more than 25 full-time equivalent employees (FTEs) employed during its tax year, and whose employees have annual full-time equivalent wages that average no more than $50,000. However, the full credit is available only to an employer with 10 or fewer FTEs and whose employees have average annual full-time equivalent wages from the employer of not more than $25,000. And, in general, the ESE must pay not less than 50% of the premium cost of the employee health plan. The new guidance examines which employers qualify for the credit and which employees may be counted for credit purposes. It includes new rules for satisfying the complex uniform contribution requirement with special transition rules for 2010. The IRS also issued the final version of Form 8941 (Credit for Small Employer Health Insurance Premiums), which is used to claim the credit.

Medical residents do not qualify for FICA student exception. Under the so-called student exception, FICA doesn’t apply to students’ work for a college if they are regularly enrolled in and attending classes at the college. The Supreme Court has upheld the validity of IRS regulations that generally prevent medical residents from qualifying for the FICA student exception. Under these regulations, an employee for FICA purposes includes a medical resident who works 40 hours or more per week for a school, college or university. This decision has important ramifications for the many teaching hospitals and their residents.

Electronic funds transfer (EFT) rules now in place. Beginning Jan. 1, 2011, employers must use EFT to make all federal tax deposits (such as deposits of employment tax, excise tax, and corporate income tax). Forms 8109 and 8109-B, Federal Tax Deposit Coupon, cannot be used after Dec. 31, 2010.

Standard mileage rates up. The optional mileage allowance for owned or leased autos (including vans, pickups or panel trucks) is 51¢ per each business mile traveled after 2010. That’s 1¢ more than the 50¢ allowance for business mileage during 2010. Further, the 2011 rate for using a car to get medical care or in connection with a move that qualifies for the moving expense deduction is 19¢ per mile, 2.5¢ more per mile than the 16.5¢ for 2010.

More interest deductions for debt on the purchase of an expensive home. In new guidance on rules for deducting qualified residence interest, the IRS has determined that acquisition debt incurred by a taxpayer to buy, build, or substantially improve a qualified residence can also qualify as home equity debt to the extent it exceeds $1 million. As a result, a taxpayer can deduct up to $1.1 million of the debt securing the purchase of his principal residence.

Basis overstatement can trigger 6-year limitations period under new regulations. The IRS has issued final regulations under which an understated amount of gross income reported on a return resulting from an overstatement of unrecovered cost or other basis is an omission of gross income for purposes of the 6-year period for assessing tax and the minimum period for assessment of tax attributable to partnership items. The 6-year limitations period applies when a taxpayer omits from gross income an amount that’s greater than 25% of the amount of gross income stated in the return. Several courts had held that a basis overstatement is not an omission of gross income for this purpose. In response to these decisions, the IRS issued the new regulations to clarify that an omission can arise in that fashion. After it initially issued these regulations as temporary ones, the Tax Court found them to be invalid. How other courts will react to the clarification remains to be seen.

Withholding on government payments delayed. For payments made after Dec. 31, 2011, governments at the federal, state and local levels will have to deduct and withhold tax in an amount equal to 3% of any payments they make to a person providing property or services. However, the IRS has announced that withholding and reporting requirements will not apply to any payment made by payment card, including credit cards, debit cards, and stored value cards, for any calendar year beginning earlier than at least 18 months from the date further guidance on this subject is finalized. Thus, the new requirements will not apply to payment card payments for the 2012 calendar year.

New law delays start of filing season for some taxpayers. Some taxpayers planning to file their 2010 tax returns early have been advised by the IRS to wait until mid- to late-February, 2011. Affected taxpayers are those planning to file Schedule A or claim above-the-line deductions for higher-education tuition and fees or educator expenses. The culprit is Congress’s late passage of the 2010 Tax Relief Act. The IRS needs time to reprogram its computers to reflect the changes.

Extended due date this year. Because of the Emancipation Day holiday in the District of Columbia, the due date of Form 1040 for 2010 is Apr. 18, 2011, instead of Apr. 15, 2011. The Apr. 18 due date applies even for taxpayers who do not live in the District of Columbia.

Tax changes in specialized legislation. Several specialized laws passed in the final days of 2010 included tax changes. The James Zadroga 9/11 Health and Compensation Act of 2010 (P.L. 111-347) imposes a tax equal to 2% of the amount of any payment received by a foreign person under a contract with the U.S. government for the provision of goods or services. The tax, which is effective for payments received under contracts entered into on and after Jan. 2, 2011, applies if the goods are manufactured or produced or if services are provided in a country that is not a party to an international procurement agreement with the U.S. The IRS has yet to issue guidance on this new law change. In addition, the Omnibus Trade Act of 2010 (P.L. 111-344) extends for a limited period of time certain generous terms for the refundable health coverage tax credit (HCTC) allowed to certain trade-affected workers and Pension Benefit Guaranty Corporation (PBGC) payees. The HCTC makes health insurance coverage more affordable for these individuals and their families by providing an income tax credit based on the amount of premiums paid. IRS pays the credit in advance, directly to the insurance provider, for individuals registered in its HCTC Program.

A college student’s guide to managing money & cutting costs

As parents, we all know that preparing a reasonable budget and sticking to it is a basic principle of good financial planning. By assisting college-bound students in developing and maintaining their own budget, parents can help students make ends meet during their college years while helping them develop good money management skills they’ll use for the rest of their lives.

Preparing a budget

• Estimate all sources of funds. The first step in preparing a budget is to identify all sources of funds. Possible sources of funds include student loans, savings, scholarships, work-study grants, student employment earnings, and family support.
• Estimate expenses. Once you’ve identified all available funds, potential expenses that may arise during the school year must be considered. These expenses will fall into one of two categories: fixed and variable.

Fixed expenses. Fixed expenses are those expenses that should not vary much throughout the year. Fixed expenses include tuition, college fees, books, supplies, rent, utilities, and insurance. Keep in mind how these expenses will need to be paid (monthly, quarterly, or annually) so a plan can be implemented to effectively manage cash flow. In addition, don’t overlook large one-time expenses such as deposits and telephone installation fees.

Variable expenses. Unlike fixed expenses, variable expenses can fluctuate greatly from month to month, even from day to day. For budgeting purposes, variable expenses are harder to estimate than fixed expenses but since they are not fixed, your student usually has greater control over the amount and timing of these expenses. Examples of variable expenses are food, clothing, travel, entertainment, transportation, telephone and other miscellaneous items.

Making ends meet

Once the sources of funds and potential expenses have been identified and an initial budget has been developed, it may be obvious that making the budget work will take some effort and smart choices on your student’s part. To make sure funds last through spring, here are a few money-saving tips to pass on to your college-bound student:

Housing

Live where you learn. Living on campus in a dormitory is usually cheaper then getting an apartment off-campus and will save on transportation expenses.

Roommates are key. If your heart is set on living off campus, you can really stretch your housing dollars by sharing an apartment with one or more other college students. If you and your roommates pool your funds to buy groceries, small kitchen appliances and furniture, the savings can be even greater.

Make Mom and Dad your roommates. Living at home while you are attending a local college can save your thousands of dollars in food and rent costs.

Food

Skip the crowded, expensive on-campus eateries. Packing a lunch or snacks from home can save you lots of time and money.

Forgo the morning java at the coffeehouse. A small regular coffee at a fancy coffeehouse costs about $1.35 while a home-brewed cup of coffee costs about 7 cents.

Plan your meals. If your fridge and freezer are stocked with delicious foods that you made ahead of time, you are less likely to grab pricey convenience foods on the run.

Grocery shop like a pro. Clipping coupons, buying store generic brands, avoiding convenience foods, and shopping from a list are ways that millions of smart shoppers take a big bite out of their grocery costs every month. Shopping at stores with double coupons and “buy one, get one free” deals can get you even more bang for your shopping buck.

Develop a food co-op. Pooling coupons, buying in bulk quantities and then splitting the costs among a group of friends or other students is a great way to end up with more disposable income.

Consider school-provided meal plans. Many schools have meal plans that allow you to pay for meals in advance. This can save money while converting a variable expense into a fixed expense, further simplifying the budgeting process.

Travel & transportation

Carpool with friends. Since you and your friends are all going to the same place anyway, why not have some fun driving to school while saving money in gas. Also, check to see if your school has a “ride board” or an organized carpool program.

Buy a bus pass. If you take the bus to school more than a couple of times each week, consider getting a monthly bus pass to save time and money.

Dust off your bike or skates. Considering riding a bike, using inline skates or walking to places instead of driving or using public transportation.

Plan air travel well in advance. If you’re away at school and plan to visit home regularly, make any plane reservations months in advance to receive the best price on tickets. Make sure to take advantage of frequent flier miles and travel specials on the Internet.

Telephone

Make long-distance calls at night or on weekends. Rates can be as much as 65% less than peak period rates.

Use prepaid phone cards. Buy a month’s worth of phone cards in advance and limit yourself each month to the amount on the phone cards.

Shop for a good phone plan. Deregulation of the phone companies has resulted in a lot of choices for phone plans. Since many of these plans can involve confusing restrictions and conditions, do your homework before committing to a plan.

Get on the Internet. If you have Internet access, you have access to email, either paid or free. Instead of picking up the phone, email your friends and family for a cheap and easy form of communication.

Maintaining the budget

Once you have a budget you and your student can live with, you’re almost finished. As with any good financial plan, maintenance is critical. It’s important that your student keep an accurate record of actual expenses to compare periodically with the budgeted amounts. Actual expenses can be recorded in a small notebook or on a computer spreadsheet using detailed categories for easy comparison. This process will help you and your student determine exactly where the money goes at all times.

For the college-bound student, developing and maintaining a budget may seem like just one more headache, but it will ultimately result in a greater sense of control over their money and stronger overall financial position upon graduation.

Education tax benefits: A report card

While Congress extended the reduced individual income tax rates with passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) in late 2010, it also extended several educational tax benefits as well through 2012. As families plan their upcoming tax year, it is important to keep these benefits in mind.

American Opportunity Tax Credit

Individuals may continue to claim a credit against their federal tax liability based on tuition payments and certain related expenses. Previously referred to as the Hope Credit, the American Opportunity Tax Credit (AOTC) remains available for taxpayers for the 2011 and 2012 tax years. Qualifying families may claim an annual tax credit of up to $2,500 for undergraduate college expenses, up to $10,000 for a four-year program.  According to a recently-issued report, Treasury predicts that 9.4 million families will be able to claim a total of $18.2 billion AOTC credits in 2011, an average of $1,900 per family.

Lifetime learning credit

Taxpayers can claim the lifetime learning credit for post-high school education, as well as courses to acquire or improve job skills. These institutions include colleges, universities, vocational schools, and any other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. The lifetime learning credit is limited to $2,000 per eligible student, based upon payment of tuition and other qualified expenses.  

The IRS released Tax Tip 2010-12 reminding taxpayers that they cannot claim both the lifetime learning credit and the AOTC for one child in a single tax year. However, if the family has multiple children in college, the family may apply the credits on a “per-student, per-year basis.” This means that the family with two children in college, for example, could claim the AOTC for one child and the lifetime learning credit for the other.

Coverdell Education Savings Accounts

The 2010 Tax Relief Act also extended the increased maximum contribution amount to Coverdell education savings accounts. Taxpayers may contribute a maximum of $2,000 per year to these tax-preferred accounts. Earnings on these contributions grow tax-free, while amounts subsequently withdrawn are excludable from gross income to the extent used for qualified educational expenses.

Educational assistance programs

The 2010 Tax Relief Act also extended taxpayers’ annual exclusion of up to $5,250 in employer-provided educational assistance from their gross income. The exclusion applies to both gross income for federal income tax purposes, as well as wages for employment tax purposes.

Federal Scholarships with Service requirements

The 2010 Tax Relief Act continues the gross income exclusion for scholarships with obligatory service requirements received by candidates at certain qualified educational organizations. The exclusion applies to scholarships granted by the National Health Service Corps Scholarship Program or the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance Program.

Qualified Tuition and Expense Deduction

The 2010 Tax Relief Act also extends the above-the-line deduction for qualified tuition and related expenses through 2011. The deduction applies to tuition and fees paid for the enrollment of the taxpayer, the taxpayer’s spouse, or any dependent for which the taxpayer is entitled to a dependency exemption. Taxpayers can not claim both one of the education tax credits and the tuition and expense deduction in a single year. These continue to be either/or tax breaks.

Student loan interest deduction

Finally, after the student graduates, they may still claim an educational tax benefit by repaying their educational loans. Within certain adjusted gross income limits, taxpayers may claim a deduction for interest paid on student loans. The 2010 Tax Relief Act extends favorable limits on this deduction. Through 2012, the law extended the increased modified adjusted gross income phase-out ranges, meaning more taxpayers can claim the deduction. The 2010 Tax Relief Act also extended the repeal of the 60-month limit on deductible payments.

President’s FY 2012 proposals: Higher taxes on wealthy, limited tax breaks for businesses

Roadmap

Every federal budget proposal is just that: a proposal, or a list of recommendations from the White House to Congress. Ultimately, it is for Congress to decide whether to fund a particular government program and at what level. The same is true for tax cuts and tax increases. The final budget for FY 2012 will be a compromise. Nonetheless, President Obama’s FY 2012 budget is a helpful tool to predict in what direction federal tax policy may move.

Individuals

In his FY 2012 budget, President Obama repeats his call for Congress to end the Bush-era tax cuts for higher-income individuals (which the president generally defines as single individuals with incomes over $200,000 and married couples with incomes over $250,000). The top individual income tax rates would increase to 36 percent and 39.6 percent, respectively, after 2012. For 2011 and 2012, the top two individual income tax rates are 33 percent and 35 percent, respectively. The president also proposes to limit the deductions of higher income individuals.

Additionally, the president wants Congress to extend the reduced tax rates on capital gains and dividends, but not for higher-income individuals. Single individuals with incomes above $200,000 and married couples with incomes above $250,000 would pay capital gains and dividend taxes at 20 percent rather than at 15 percent after 2012.

The president’s FY 2012 budget, among other things, also proposes:

• An AMT patch (higher exemption amounts and other targeted relief) after 2011;
• A permanent American Opportunity Tax Credit (enhanced Hope education tax credit) after 2012;
• A permanent enhanced earned income credit;
• A new exclusion from income for certain higher education student loan forgiveness;
• One-time payments of $250 to Social Security beneficiaries, disabled veterans and others with a corresponding tax credit for retirees who do not receive Social Security; and
• A temporary extension of certain tax incentives, such as the state and local sales tax deduction and the higher education tuition deduction, for one year.

Some of the proposals in the president’s FY 2012 budget impact how individuals interact with the IRS. Many taxpayers complain that when they call the IRS, the wait times to speak to an IRS representative are so long they hang up. The president proposes to increase the IRS’s budget to hire more customer service representatives. The president also proposes to allow the IRS to accept debit and credit card payments directly, thereby enabling taxpayers to avoid third party processing fees.

Businesses

The tax incentives for businesses in the president’s FY 2012 budget are generally targeted to specific industries. One popular but temporary business tax incentive would be made permanent. President Obama proposes to extend permanently the research tax credit. The president also proposes to permanently abolish capital gains tax on investments in certain small businesses.

Other business proposals include:

1. Employer tax credits for creating jobs in newly designated Growth Zones;
2. Additional tax breaks for investments in energy-efficient property;
3. More funds for grants in lieu of tax credits for specified energy property;
4. One-year extensions of some temporary business tax incentives, such as the Indian employment credit and environmental remediation expensing;
5. Modifying Form 1099 business information reporting; and
6. Extending and reforming Build America Bonds.

The president’s FY 2012 budget does not include a cut in the U.S. corporate tax rate. Any reduction in the U.S. corporate tax rate is likely to come outside the budget process. The president has spoken often in recent weeks about reducing the U.S. corporate tax rate but he wants any reduction to be revenue neutral; that is, the cost of cutting the U.S. corporate tax rate must be paid for. President Obama has discussed closing some unspecific tax loopholes.

IRS operations

President Obama proposes a significant increase in funding for the IRS. Most of the money would go to hiring new revenue officers and boosting enforcement activities. The White House predicts that investing $13 billion in the IRS over the next 10 years will generate an additional $56 billion in additional tax revenue over the same time period.

Estate tax

Late last year, the White House and the GOP agreed on a maximum federal estate tax rate of 35 percent with a $5 million exclusion for 2010, 2011 and 2012. In his FY 2012 budget, the president proposes to return the federal estate tax to its 2009 levels after 2012 (a maximum tax rate of 45 percent and a $3.5 million exclusion). President Obama also proposes to limit the duration of the generation skipping transfer (GST) tax exemption and to make other estate-tax related changes.

Revenue raisers

The White House and Congress are both looking at ways to cut the federal budget deficit. Taxes are one way. The president’s FY 2012 budget proposes a number of revenue raisers, especially in the area of international taxation and in fossil fuel production.

International taxation. The president’s budget proposes to reduce tax incentives for U.S.-based multinational companies. One goal of this strategy is to encourage multinational companies to invest in job creation in the U.S. The president’s FY 2012 budget calls for, among other things, to limit earnings stripping by expatriated entities, to limit income shifting through intangible property transfers, and to make more reforms to the foreign tax credit rules. If enacted, all of the proposed international taxation reforms would raise an estimated $129 billion in additional revenue over 10 years.

LIFO. President Obama proposes to repeal the last-in, first-out (LIFO) inventory accounting method for federal income tax purposes. Taxpayers that currently use the LIFO method would be required to write up their beginning LIFO inventory to its first-in, first-out (FIFO) value in the first tax year beginning after December 31, 2012. This proposal would raise an estimated $52.8 billion over 10 years.

Fossil fuel tax preferences. The Tax Code includes a number of tax incentives for oil, gas and coal producers. President Obama proposes to repeal nearly all of these tax breaks for oil, gas and coal companies. These proposals would raise an estimated $46.1 billion over 10 years.

Financial institutions. President Obama proposes to impose a financial crisis responsibility fee on large U.S. financial institutions. The fee, if enacted, would raise an estimated $30 billion in additional revenue over 10 years.

Carried interest. The president’s FY 2012 budget proposes to tax carried interest as ordinary income. This proposal would raise an estimated $14.8 billion in additional revenue over 10 years.

Insurance company reforms. Insurance companies are subject to specific and very technical tax rules. President Obama proposes to overhaul the tax rules for insurance companies. If enacted, these reforms would raise an estimated $14 billion over 10 years.

These are just some of the revenue raisers in the president’s FY 2012 budget. All of them will be extensively debated in Congress in the coming months. We will keep you posted on developments.

Scope of information reporting to IRS continues to expand

Information reporting continues to expand as Congress seeks to close the tax gap: the estimated $350 billion difference between what taxpayers owe and what they pay. Despite the recent rollback of expanded information reporting for business payments and rental property expense payments, the trend is for more – not less – information reporting of various transactions to the IRS.

Transactions

A large number of transactions are required to be reported to the IRS on an information return. The most common transaction is the payment of wages to employees. Every year, tens of millions of Forms W-2 are issued to employees. A copy of every Form W-2 is also provided to the IRS. Besides wages, information reporting touches many other transactions. For example, certain agricultural payments are reported on Form 1099-G, certain dividends are reported on Form 1099-DIV, certain IRA distributions are reported on Form 1099-R, certain gambling winnings are reported on Form W-2G, and so on. The IRS receives more than two billion information returns every year.

Valuable to IRS

Information reporting is valuable to the IRS because the agency can match the information reported by the employer, seller or other taxpayer with the information reported by the employee, purchaser or other taxpayer. When information does not match, this raises a red flag at the IRS. Let’s look at an example:

Silvio borrowed funds to pay for college. Silvio’s lender agreed to forgive a percentage of the debt if Silvio agreed to direct debit of his monthly repayments. This forgiveness of debt was reported by the lender to Silvio and the IRS. However, when Silvio filed his federal income tax return, he forgot, in good faith, to report the forgiveness of debt. The IRS was aware of the transaction because the lender filed an information return with the IRS.

Expansion

In recent years, Congress has enacted new information reporting requirements. Among the new requirements are ones for reporting the cost of employer-provided health insurance to employees, broker reporting of certain stock transactions and payment card reporting (all discussed below).

Employer-provided health insurance. The Patient Protection and Affordable Care Act requires employers to advise employees of the cost of employer-provided health insurance. This information will be provided to employees on Form W-2.

This reporting requirement is optional for all employers in 2011, the IRS has explained. There is additional relief for small employers. Employers filing fewer than 250 W-2 forms with the IRS are not required to report this information for 2011and 2012. The IRS may extend this relief beyond 2012. We will keep you posted of developments.

Reporting of employer-provided health insurance is for informational purposes only, the IRS has explained. It is intended to show employees the value of their health care benefits so they can be more informed consumers.

Broker reporting. Reporting is required for most stock purchased in 2011 and all stock purchased in 2012 and later years, the IRS has explained. The IRS has expanded Form 1099-B to include the cost or other basis of stock and mutual fund shares sold or exchanged during the year. Stock brokers and mutual fund companies will use this form to make these expanded year-end reports. The expanded form will also be used to report whether gain or loss realized on these transactions is long-term (held more than one year) or short-term (held one year or less), a key factor affecting the tax treatment of gain or loss.

Payment card reporting. Various payment card transactions after 2010 must be reported to the IRS. This reporting does not affect individuals using a credit or debit card to make a purchase, the IRS has explained. Reporting will be made by the payment settlement entities, such as banks. Payment settlement entities are required to report payments made to merchants for goods and services in settlement of payment card and third-party payment network transactions.

Roll back

In 2010, Congress expanded information reporting but this time there was a backlash. The PPACA required businesses and certain other taxpayers to file an information return when they make annual purchases aggregating $600 or more to a single vendor (other than a tax-exempt vendor) for payments made after December 31, 2011. The PPACA also repealed the long-standing reporting exception for payments made to corporations. The Small Business Jobs Act of 2010 required information reporting by landlords of certain rental property expense payments of $600 or more to a service provider made after December 31, 2011.

Many businesses, especially small businesses, warned that compliance would be costly. After several failed attempts, Congress passed legislation in April 2011 (H.R. 4, the Comprehensive 1099 Taxpayer Protection Act) to repeal both expanded business information reporting and rental property expense reporting.

The future

In April 2011, IRS Commissioner Douglas Shulman described his vision for tax collection in the future in a speech in Washington, D.C. Information reporting is at the center of Shulman’s vision.

Shulman explained that the IRS would get all information returns from third parties before taxpayers filed their returns. Taxpayers or their professional return preparers would then access that information, online, and download it into their returns. Taxpayers would then add any self-reported and supplemental information to their returns, and file their returns with the IRS. The IRS would embed this core third-party information into its pre-screening filters, and would immediately reject any return that did not match up with its records.

Shulman acknowledged that this system would take time and resources to develop. But the trend is in favor of more, not less, information reporting.

Key developments during the first quarter of 2011

The following is a summary of the most important tax developments that have occurred in the past three months that may affect you, your family, your investments, and your livelihood.

Guidance on 100% bonus depreciation and other bonus depreciation issues.The IRS has issued detailed guidance on the 2010 Tax Relief Act’s 100% bonus depreciation rules for qualifying new property generally acquired and placed in service after Sept. 8, 2010 and before Jan. 1, 2012. Overall, the rules are quite generous. For example, they permit 100% bonus depreciation for components, even if work on a larger self-constructed property that includes the components began before Sept. 9, 2010, allow a taxpayer to elect to “step down” from 100% to 50% bonus depreciation for property placed in service in a tax year that includes Sept. 9, 2010, and provide an escape hatch for some business car owners who would otherwise be subject to a draconian depreciation result. The guidance also addresses other bonus depreciation issues. For example, the guidance permits 100% bonus depreciation for qualified restaurant property or qualified retail improvement property that also meets the definition of qualified leasehold improvement property.

New law creates a 100% write-off for heavy SUVs used entirely for business.Under the 2010 Tax Relief Act, a taxpayer that buys and places in service a new heavy SUV after Sept. 8, 2010 and before Jan. 1, 2012, and uses it 100% for business, may write off its entire cost in the placed-in-service year. A heavy SUV is one with a gross vehicle weight (GVW) rating of more than 6,000 pounds.

IRS further delays health insurance coverage information reporting for small employers.The new health reform legislation generally requires employers to report the cost of health insurance they provide to employees on their W-2 forms. Last fall, the IRS made this new reporting requirement optional for all employers for the 2011 Forms W-2. More recently, the IRS announced that the reporting requirement will continue to be voluntary for small employers (i.e., those filing fewer than 250 Forms W-2) at least through 2012, or until further guidance is issued by IRS.

New settlement offer for those voluntarily disclosing unreported offshore income.The IRS has announced a second voluntary disclosure initiative designed to bring offshore money back into the U.S. tax system and help people with undisclosed income from hidden offshore accounts get current with their taxes. It will be available through Aug. 31, 2011. The IRS released details of the new voluntary offer, called the 2011 Offshore Voluntary Disclosure Initiative (OVDI), in the form of 53 frequently asked questions (FAQs). As with the first offer, participants have to pay back taxes and penalties but will avoid criminal prosecution. The offshore penalty is different under the new offer. The general rule is that the penalty is 25% based on amounts in foreign bank accounts, but can be as low as 12.5% or 5% for some taxpayers.

IRS eases lien procedures.The IRS has announced new policies and programs to help taxpayers pay back taxes and avoid tax liens. Its goal is to help individuals and small businesses meet their tax obligations, without adding an unnecessary burden to taxpayers. Specifically, the IRS is:

• Significantly increasing the dollar threshold when liens are generally issued, resulting in fewer tax liens.
• Making it easier for taxpayers to obtain lien withdrawals after paying a tax bill.
• Withdrawing liens in most cases where a taxpayer enters into a Direct Debit Installment Agreement.
• Creating easier access to Installment Agreements for more struggling small businesses; and
• Expanding a streamlined Offer in Compromise program to cover more taxpayers.

Lactation expenses now qualify as deductible medical expenses.Reversing its prior position, the IRS has announced that expenses paid for breast pumps and supplies that assist lactation qualify as deductible medical expenses. Amounts reimbursed for these expenses under FSAs (flexible spending accounts), Archer MSAs (medical savings accounts), HRAs (health reimbursement arrangements), or HSAs (health savings accounts) are accordingly not income to the taxpayer.

Tax consequences of governmental homeowner-assistance payments.The IRS has explained the income tax and information return consequences of payments made to or on behalf of homeowners under various government programs designed to prevent avoidable foreclosures of homeowners’ homes and stabilize housing markets. In general, homeowners may exclude the payments from income, and may deduct all payments they actually make during 2010–2012 to the mortgage servicer, HUD (the Department of Housing and Urban Development), or the State HFA (housing finance agency) on the home mortgage. The aid payments aren’t subject to information reporting, and there are transition rules for payments that are incorrectly reported.

Courts differ over whether basis overstatement can trigger 6-year limitations period under new regulations.Late last year, the IRS issued final regulations under which an understated amount of gross income reported on a return resulting from an overstatement of unrecovered cost or other basis is an omission of gross income for purposes of the 6-year period for assessing tax and the minimum period for assessment of tax attributable to partnership items. The 6-year limitations period applies when a taxpayer omits from gross income an amount that’s greater than 25% of the amount of gross income stated in the return. Several courts had held that a basis overstatement is not an omission of gross income for this purpose. In response to these decisions, the IRS issued the new regulations to clarify that an omission can arise in that fashion. Now, some Courts have addressed the regulations. The Court of Appeals for the Fourth Circuit and the Tax Court have rejected the regulations. On the other hand, the Federal Circuit has upheld them and the Seventh Circuit has viewed them favorably. As a result, it looks like the Supreme Court will ultimately have to resolve the issue.

New deadline for electing modified carryover basis rules.Estates of decedents dying in 2010 can choose zero estate tax, but at the price of beneficiaries being limited to the decedents’ basis plus certain increases. The IRS has announced that Form 8939, Allocation of Increase in Basis for Property Acquired From a Decedent, is not due Apr. 18, 2011 and should not be filed with the final Form 1040 of persons who died in 2010. The IRS says the due date will be set in forthcoming guidance but does not indicate when that guidance may be issued. The forthcoming guidance will also explain the manner in which an executor of an estate may elect to have the estate tax not apply for a decedent dying in 2010.

Another Appeals Court upholds IRS’s time limit on spousal relief requests.Married joint return filers are jointly and severally liable for the tax arising from their returns. Innocent spouses may request relief from this liability in certain circumstances. An IRS regulation states that a request for equitable innocent spouse relief must be no later than two years from the first collection activity against the spouse. The Tax Court had found this regulation invalidly imposed a time limit. However, the Court of Appeals for the Third Circuit has reversed the Tax Court and upheld the regulation (so has the Court of Appeals for the Seventh Circuit).

Business expenses of professional gamblers not limited.Gambling losses may be deducted only to the extent of gambling winnings, even in the case of an individual engaged in the trade or business of gambling. Previously, the Tax Court had held that losses for purposes of the limitation included both the cost of wagers and business expenses. Earlier this year, the Court overruled its prior position and now says that a professional gambler’s business expenses are not subject to the loss limitation.

Physician statement alone doesn’t establish financial disability to toll limitations period. In general, a taxpayer must file a claim for credit or refund of tax within three years after filing the return or two years after paying the tax, whichever period expires later. (Code Sec. 6511(a)) However, the statute of limitations is suspended for certain taxpayers who are unable to manage their financial affairs because of a medically determinable mental or physical impairment. A physician’s statement must be submitted to claim this relief, but a Court has made clear that the statement alone doesn’t establish that the taxpayer was financially disabled. Thus, it allowed the IRS to seek additional proof of the taxpayer’s condition.

IRAs 101

At one time, there was relatively little confusion about IRAs because there was only one type available. Now, however, IRAs have proliferated—there’s the “traditional” IRA, which may be funded with deductible and/or nondeductible contributions, Roth IRA, SEP-IRA, and SIMPLE IRA. Some of these IRAs have similar features, but others have features that are unique.

What do all these IRAs have in common? They can help you and your family save significant amounts for retirement on a tax-favored basis. Here’s an overview of the different types of IRAs available today.

Traditional IRAs

Traditional IRAs can be funded with deductible and nondeductible contributions.

Deductible IRA contributions. You can make an annual deductible contribution to an IRA if:

(1) you (and your spouse) are not an active participant in an employer-sponsored retirement plan, or

(2) you (or your spouse) are an active participant in an employer plan, and your modified adjusted gross income (AGI) doesn’t exceed certain levels that vary from year-to-year by filing status.

For example, in 2011, if you are a joint return filer covered by an employer plan, your deductible IRA contribution phases out over $90,000 to $110,000 of modified AGI. If you’re single or a head of household in 2011, the phaseout range is $56,000 to $66,000. For a married filing separately, the phaseout range is $0 to $10,000 (for all years). In 2011, if you are not an active participant in an employer-sponsored retirement plan, but your spouse is, your deductible IRA contribution phases out with modified AGI of between $169,000 and $179,000.

Deductible IRA contributions reduce your current tax bill, and earnings within the IRA are tax-deferred. However, every dollar you take out is taxed in full (and subject to a 10% penalty if you withdraw money before age 59¹/₂, unless one of several exceptions apply). You must begin making minimum withdrawals by April 1 of the year following the year you attain age 70¹/₂.

Nondeductible IRA contributions. You can make an annual nondeductible IRA contribution without regard to your coverage by an employer plan and without regard to your AGI. The earnings in a nondeductible IRA are tax-deferred within the IRA, but are taxed on distribution (and subject to a 10% penalty if you withdraw money before age 59¹/₂, unless one of several exceptions apply).

You must begin making minimum withdrawals by April 1 of the year following the year you attain age 70¹/₂. Nondeductible contributions aren’t taxed when they are withdrawn. If you’ve made deductible and nondeductible IRA contributions, a portion of each IRA distribution is treated as coming from nontaxable IRA contributions (and the rest is taxed).

If you can’t make a deductible contribution to a traditional IRA, you should contribute (if eligible) to a Roth IRA instead of making a nondeductible contribution to a traditional IRA. That’s because the Roth IRA offers a better package of tax benefits than you’d get by making a nondeductible contribution to a traditional IRA.

Deductible and nondeductible IRA limits. The maximum annual IRA contribution (deductible or nondeductible, or a combination) is $5,000 for 2011 ($6,000 if you are age 50 or over in 2011). Additionally, your IRA contribution for a year (deductible or not) can’t exceed the amount of your compensation includible in income for that year. Deductible and nondeductible IRA contributions can’t be made once you attain age 70¹/₂.

IRAs often are referred to as “traditional IRAs” (or “regular IRAs”) to distinguish them from Roth IRAs.

Roth IRAs.

You can make an annual contribution to a Roth IRA if your AGI doesn’t exceed certain levels that vary by filing status. For example, in 2011, if you are a joint return filer, the maximum annual Roth IRA contribution phases out between $169,000 and $179,000 of modified AGI ($107,000 to $122,000 for single taxpayers). Annual contributions to Roth IRAs can be made up to the amount that would be allowed as a contribution to a traditional IRA, reduced by the amount you contribute for the year to non-Roth IRAs, but not reduced by contributions to a SEP IRA or SIMPLE IRA (see below). For example, if you don’t contribute to a traditional IRA in 2011, you can contribute up to $5,000 to a Roth IRA for that year ($6,000 if you are age 50 or older in 2011).

Roth IRA contributions aren’t deductible. However, earnings are tax-deferred within the Roth IRA and (unlike a traditional IRA) are tax-free if paid out (1) after a five-year period that begins with the first year for which you made a contribution to a Roth IRA, and (2) once you reach age 59¹/₂, or upon death or disability, or (up to $10,000 lifetime) for first-time home-buyer expenses of you, your spouse, child, grandchild, or ancestor. And if a Roth IRA payout doesn’t meet these dual conditions, you’re treated as first withdrawing nontaxable Roth IRA contributions; the balance (representing earnings) is taxed and is subject to a 10% penalty for pre-age-59¹/₂ withdrawals, unless one of several exceptions apply. Thus, for example, if you contribute $6,000 over the years to Roth IRAs and withdraw $9,000 at age 55 to buy a boat, only $3,000 is taxed (and is subject to the 10% penalty).

You can make Roth IRA contributions even after you attain age 70¹/₂ (if you have sufficient compensation income), and you do not have to take minimum distributions from a Roth IRA after you attain that age. That makes Roth IRAs an excellent wealth-building vehicle for your family.

You can “roll over” (or convert) a traditional IRA to a Roth IRA regardless of the amount of your AGI (before 2010, a limit applied based on your AGI). The amount taken out of the traditional IRA and rolled over to the Roth IRA is treated for tax purposes as a regular withdrawal (but it’s not subject to the 10% early withdrawal penalty).

SEP IRAs and SIMPLE IRAs

Small businesses that want to provide employees with a retirement plan, but keep administrative costs low, may be able to set up a SEP (simplified employee pension) or SIMPLE (savings incentive match plan for employees) plan. In either type of plan, contributions are made to IRA-type accounts in the employees’ names. Annual contributions to these plans are controlled by special rules and aren’t tied to the normal IRA contribution limits. Distributions from a SEP IRA or SIMPLE IRA are subject to tax rules similar to those that apply to deductible IRAs.

Income tax credit for contributions to IRAs

If your adjusted gross income doesn’t exceed specified levels, you may be entitled to a credit (saver’s credit) against your income tax equal to a percentage of your contribution to any of the above IRAs. If you are entitled to the credit, you get it in addition to any deduction you may be entitled to for the same contribution.

Costly Tax Errors to Avoid When Funding College Education

With the cost of financing a college education rising twice as fast as inflation, the dream of sending a child to college is becoming more like a nightmare. The increase in college costs is out-pacing both inflation and the increase in family income. A family just can’t afford to make any costly errors.  Here are three to avoid:

1-   Paying for college from a grandparent’s 529 plan – A 529 plan can be an excellent way for grandparents to contribute to a grandchild’s college education while simultaneously paring down their own estate. A big advantage of 529 plans is that under special rules, grandparents can make a joint lump-sum gift of up to $130,000 ($65,000 for individual gifts) to a 529 account and completely avoid federal gift tax…and the assets in the plan do not have to be included on the  FAFSA completed by the grandchild and his/her parents.

This strategy works great for families that will not qualify for financial aid…no harm, no foul.   However, for families that will qualify for financial aid, the amount withdrawn from the 529 plan is considered as untaxed income to the student on the FAFSA and reduces need-based financial aid by 50 cents for every 529 Plan dollar withdrawn. 

2-   Grandparents that pay college bills directly to the institution – Another excellent way for grandparents to help their grandchildren with college costs is to pay the college directly. Under federal law, tuition payments made directly to a college aren’t considered taxable gifts, no matter how large the payment.  Plus, it removes the money from their estate.

Again, this strategy continues to works well for families that will not qualify for financial aid.  However, for families that will qualify for financial aid, the amount paid by the grandparent is considered as a “resource” to the student for financial aid purposes, and reduces need-based financial aid dollar for dollar. 

3-   Using 529 Plan money to pay for Lifetime Learning Credit expenses – Families with incomes of $100,000, or less, can claim 20% of the first $10,000 tuition and fees as a tax credit.  However, if they use 529 Plan distributions to pay for those same tuition and fees, they lose the tax-free status of the withdrawn earnings.  Furthermore, 529 Plan distributions subject to income tax will be counted as untaxed income in the determination of financial aid eligibility.

The “Net Qualified Education Expenses” must be determined to figure what portion, if any, of earnings withdrawals from a 529 Plan are truly tax-free.  Before earnings can be considered to be tax-free, certain non-taxable items need to be deducted from the withdrawals including tax-free scholarships, Pell grants, and expenses used to claim the education tax credits.

For example, assume a family withdraws $25,000 from their 529 Plan which includes $6,000 of earnings.  The student has also received a $5,000 scholarship and claims the $2,000 Lifetime Learning Credit.  Therefore, we calculate the Net Qualified Education Expenses (NQE) as follows:

          529 Plan withdrawal                           $25,000

          Scholarship                                            -5,000

          Tuition & fees used for credit               -10,000

              NQE                                                 $10,000   

Since the $10,000 NQE represents 40% ($10,000/$25,000) of the 529 Plan withdrawal, we apply the same percentage to determine the amount of earnings that are tax exempt.  Therefore, $2,400 ($6,000 x 40%) of the earnings is exempt and the other $3,600 is taxable.

First-Year Depreciation Incentives Are Ending Soon

As we all know, the recession caused Congress to dramatically increase tax incentives for businesses that expend amounts for capital equipment and certain building improvements. Congress expanded the long-standing Section 179 deduction to the point that it is currently at $500,000 per year. Similarly, Congress added an incentive in the form of 100% bonus depreciation for many new (rather than used) asset additions.

Congress extended these provisions into 2012, but did so at reduced amounts. With the economy gradually recovering and the budget pressures greater than ever, our expectation is that these 2012 limits signal the end of the large first-year deductions.

Overview of Bonus Depreciation

From 2008 through most of 2010, the bonus depreciation deduction was 50% of the cost of new assets. For assets acquired and placed in service from 9/9/10 through 12/31/11, the deduction moves up to 100%. Congress has also extended the deduction into 2012, but at a lower 50% rate. Presently, the tax law does not extend bonus depreciation after 12/31/12, and it appears that any extension is unlikely.

To qualify for either 100% or 50% bonus depreciation, the asset must have its original use commence with the taxpayer (i.e., it is new rather than used property), and must have a depreciable life of 20 years or less. Virtually all tangible personal property (such as autos, trucks, machinery, and equipment) has a depreciable recovery period of 20 years or less, and accordingly all are eligible.

Overview of Section 179 Deduction

For most of the past decade, the Section 179 deduction was maximized at just over $100,000. When the recession hit, Congress bumped the limit to $250,000, but later increased the amount to $500,000 for tax years beginning in 2010 and 2011. More recently, Congress indicated that for tax years beginning in 2012, the Section 179 deduction would drop back to a $125,000 (although inflation indexing is applied, and the actual number should be $130,000–$135,000).

Not only will the Section 179 deduction shrink beginning in 2012, but fewer small businesses will have access to this write-off. During 2011, the deduction phases-out only if a taxpayer’s eligible Section 179 asset purchases exceed $2 million. Starting in 2012, the phase-out threshold is $500,000 of asset additions.

The Section 179 deduction applies to both new and used asset additions. It applies to machinery and equipment, software, and, for 2011 only, up to $250,000 of qualified real property improvements. Qualified real property improvements include improvements to restaurant buildings and interiors of retail and leased nonresidential buildings. Farmers can also claim the Section 179 deduction on special use or single purpose ag buildings such as bins, drying systems, and livestock barns. However, it is not available for general purpose ag buildings such as machine sheds and shops, nor is it generally available to landlords who purchase or construct assets that are used by a tenant.

Quick Reference Chart

The following chart is a summary of the first-year depreciation incentives that are in the law through 2012, as well as the amounts that we expect to be applicable for 2013 and after. The latest legislation from Congress for 2012 seems to signal that these incentives are ending, and that the new norm for the Section 179 deduction would be $125,000, although adjusted upward for annual inflation indexing.

Here is the summary chart:

First-Year Depreciation Incentives
	Calendar		Section 179		Bonus
	Year		Limit (1, 2, 3)		Depreciation (4 ,5)
	2011		$500,000		100%
	2012		125,000		50%
	2013 (estimated)		125,000		0%

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1-Fiscal year taxpayers apply the Section 179 limit for the tax year beginning in 2011, 2012, or 2013.

2-The 2012 (and estimated 2013) Section 179 limits are inflation-indexed by reference to 2006.

3-Both new and used asset additions qualify.

4-The asset must have its original use commence with the taxpayer (i.e. only new assets qualify).

5-All taxpayers, regardless of whether reporting on a calendar or fiscal tax year, apply the bonus depreciation % based on which calendar year the asset was acquired and placed in service.

If you are planning on taking advantage of major purchases or improvements while these large allowances are still in the tax law, we recommend that you have a detailed depreciation projection prepared. These depreciation incentives can shelter a significant amount of income, but the eligibility rules can be tricky and it’s important to have an accurate expectation of the deductions that will be coming your way.

 

Rethinking a C Corporation as a Choice of Entity

Over the past several years, the choice for the formation of a new entity has frequently been an S Corporation or Limited Liability Corporation, usually to avoid the double taxation resulting from the disposition of the business.  This Blog summarizes the special tax advantages available to C Corporation shareholders who sell stock in qualified small business corporations (QSBCs). A QSBC is a C corporation that meets certain criteria. The potential tax benefits can represent a significant inducement to form a C Corporation instead of an S Corporation or Limited Liability Corporation. Therefore, it is important to understand these benefits and plan for them to be available when possible.

Stock will either be QSBC stock in the hands of shareholders or not. QSBCs are treated as regular C corporations for all other legal and federal tax purposes. (Beyond the federal income tax gain exclusion and gain rollover breaks, the standard advantages and disadvantages of C corporation status apply equally to QSBCs.) To be eligible for the QSBC gain exclusion and gain rollover breaks, stock must meet the requirements set forth in IRC Sec. 1202, including the following:

•The stock must have been issued after 8/10/93 by a C Corporation with aggregate assets of $50 million or less, and the taxpayer generally must have acquired the stock: (1) upon original issuance (either directly or through an underwriter) or (2) through gift or inheritance.

•The stock must be acquired in exchange for money, other property (not including stock), or services (not including services performed as an underwriter). However, some tax-free transfers and exchanges can also qualify, such as when stock is acquired through gift or inheritance.

•The corporation must be a QSBC at the date of the stock issuance and during substantially all the period the taxpayer holds the stock.

The following do not qualify as a QSBC [IRC Sec. 1202(e)(3)]:

1. any trade or business involving the performance of services in the fields of  health, law, engineering, architecture, accounting, etc.;

2. banking, insurance, financing, leasing, investing, or similar business;

3. farming (including the business of raising or harvesting trees);

4. the production or extraction of products subject to percentage depletion; and

5. a hotel, motel, restaurant, or similar business.

In addition, a corporation will not be treated as a QSBC for any period during which more than 10% of the total value of its assets consists of real property that is not used in the active conduct of a qualified trade or business. For purposes of the preceding sentence, the ownership of, dealing in, or renting of real property will not be treated as the active conduct of a qualified trade or business.

An eligible corporation is any domestic C corporation other than (1) a DISC or former DISC; (2) a corporation (or its subsidiary) that has a Section 936 (i.e., possessions credit) election in effect; (3) a regulated investment company (RIC), real estate investment trust (REIT), or REMIC; or (4) a cooperative [IRC Sec. 1202(e)(4)].

Special QSBC Tax Benefits

The unique income tax benefits available to sellers of QSBC stock are:

•        The ability to exclude a portion of the resulting gains from taxation if the stock was acquired:
~ between September 28, 2010 and December 31, 2011 – 100% excluded
~ between February 18, 2009 and September 27, 2010 – 75% excluded
~ between August 11, 1993 and February 17, 2009 – 50% excluded
~ after December 31, 2011 – 50% excluded

•        The ability to roll over (defer) gains by reinvesting in newly issued shares of another QSBC. The gain exclusion and gain rollover is available only for original issue shares received after August 10, 1993 and held for over five years. Shareholders that are themselves C corporations are ineligible. The taxable part of the gain from the sale of QSBC stock is taxed at 28% up to the amount of excluded gain.

Calculating the Gain Exclusion Limits

Note that IRC Sec.[1]1202(b)(1) limits the amount of gain eligible for the 50% (75% for stock acquired after February 17, 2009 and before September 28, 2010, and 100% for stock acquired after September 27, 2010, and before January 1, 2012) exclusion in a tax year with respect to a particular QSBC to the greater of

• 10 times the taxpayer’s aggregate adjusted basis in the qualified small business stock that is sold, or
• $10 million ($5 million for married filing separate status) reduced by the amount of eligible gain taken into account in prior tax years for dispositions of stock issued by the same corporation. This limitation is a lifetime per corporation limitation – it applies to the cumulative gains from dispositions of qualified small business stock.

Below are examples of the operation of each limitation:

Example 1 – $10 million eligible gain limitation

Tom and Glenda Henderson, who file a joint return, sold qualified small business stock acquired January 3, 2004 with a basis of $600,000 for a gain of $30 million in 2011. This was the first time they sold stock in that corporation. The maximum gain eligible for the 50% exclusion is the greater of $6 million (10 times the basis of the stock sold) or $10 million reduced by eligible gain taken into account in prior tax years (i.e., $10 million minus zero). Thus, the Hendersons can exclude $5 million of gain from gross income (50% of $10 million).

Example 2 – 10 times the basis limitation

Steve and Nancy Larsen, who file a joint return, sold qualified small business stock acquired June 25, 2001 with a basis of $3 million for a gain of $8 million in 2011. They had taken eligible gains of $7 million into account in earlier tax years related to this same corporation. The maximum gain eligible for exclusion is the greater of $30 million (10 times the basis) or $3 million ($10 million less the $7 million used up”). Thus, the Larsens entire $8 million gain is eligible for the 50% exclusion (under the 10 times the basis limitation), and they can exclude $4 million of gain.

In summary, a C Corporation certainly deserves entity consideration for businesses that can meet the qualifications for a QSBC. The QSBC benefits need to be evaluated alongside the benefits of an S Corp and LLC and the long-term plans of the owners.