No Will? You May Want to Think Again.


A person who fails to execute a will effectively allows the state to do it for him. If some state laws were put in the form of a will, it would look something like the one below.

I, _________________________, hereby publish and declare this to be my Last Will and Testament.

ARTICLE I

My spouse shall have one-third of my property, and my children shall have the other two-thirds, even if my children are minors or even infants at the time of my death.

ARTICLE II

The Probate Court may appoint anyone of its own choosing to be my personal representative and probe into my personal affairs.

ARTICLE III

If my spouse survives me, I appoint her (him) as guardian of my minor children. However, I require that she (he) give periodic accountings to the Probate Court of the expenditures on behalf of my children.

  1. I also require that my spouse obtain a bond to assure that she (he) carries out the guardianship duties satisfactorily.
  2. Further, when my children reach the legal age of majority, they may demand a full accounting from my spouse of all funds expended on their behalf.
  3. In the event my spouse does not survive me, then the Probate Court may select anyone it wishes to be the guardian of my minor children.

ARTICLE IV

If my surviving spouse remarries, her second husband (his second wife) shall be entitled to at least one-third of my surviving spouse’s property, including that which I left to her (him). The second husband (wife) shall not be obligated to use any of my original property or my spouse’s property to support my children.

ARTICLE V

While there are steps I could take to reduce my income and death taxes, I have consciously decided to pay as much tax as possible to the state and federal governments, rather than preserving such funds for the benefit of my family.

ARTICLE VI

If all of my family predeceases me, I cheerfully leave all of my property to the State of _____________________________.

In witness whereof, I have executed this, my Last Will and Testament, this ____________________ day of ____________________, 20____________

_______________________________
Intestate

The above “will simile” is sometimes used to point out the necessity of having a will. Some couples think that all their assets will automatically pass to the surviving spouse upon their death, which is not the case. However, many of a couple’s significant assets will pass via title or beneficiary designation. For example, if the title to their home is “joint tenants with rights of survivorship” the home will pass to the surviving spouse…with or without a will. Similarly, a life insurance policy, IRA, 401(k) and other retirement accounts will pass via beneficiary designations…with or without a will.

One of the important reasons for a couple with minor children to have a will is to name their choice of a custodian for their children in the event they both die in a common accident. The court has final authority to appoint the guardian, but the testator’s nomination is given high regard by the court.

Lastly, you can bequest specific items of personal property (jewelry, art, family heirlooms) in your will. This specific bequest is stated in your will and provides that if that particular beneficiary is not living, then the property passes to an alternate beneficiary or passes as a general gift to a group of beneficiaries.

Posted by Don James, CPA, CFP

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Taking Advantage of the R&D Tax Credit


Based on the nature of your business activities, you may qualify for the Research and Development (R&D) tax credit. Although we tend to think of R&D as limited to complex lab experiments, the Code offers a more flexible definition of R&D that encompasses a variety of industries and activities. In general, the credit covers activities that are intended to eliminate uncertainty about a particular product or process. Your research must be technological in nature and grounded in one of the hard sciences. In addition, substantially all of your research must contain elements of a process of experimentation where various alternatives are considered.

The R&D credit, also known as the research and experimentation (R&E) credit, was first introduced by Congress in 1981. The credit’s purpose is to reward U.S. firms for increasing spending on research and development within the U.S. The R&D credit is available to businesses that uncover new, improved, or technologically advanced products, processes, principles, methodologies, or materials. In addition to “revolutionary” activities, the credit may be available if a firm has performed “evolutionary” activities such as investing time, money, and resources toward improving its products and processes. Correctly calculating the R&D credit is critical, because the credit can be used to lower a firm’s effective tax rate and generate increased cash flow. Also, the credit can serve to further catalyze R&D capabilities and innovation.

The R&D credit continues to be underutilized by qualified firms and their business management teams. Reasons include a misunderstanding of qualification and documentation requirements for federal and state credits; fear of triggering an IRS audit in the current or prior year tax returns; and the perception that the credits are limited in scope or fleeting in nature due to their persistently short renewal periods.

In addition, recently-enacted legislation makes it easier for small businesses to take advantage of the R&D tax credit. Eligible small businesses may now use the credit to offset alternative minimum tax liabilities. Also, certain start-up businesses with gross receipts of less than $5 million may elect to offset their payroll taxes with the credit. Now is the perfect time to see if the R&D tax credit would be beneficial for you.

I would be happy to discuss this matter with you. We have consultants which can help you identify potential projects and costs that would qualify for the credit. We can also discuss ways to properly document your research activities in case of an IRS audit. Please contact me at don@kiplingerco.com to set up an exploratory no cost, no obligation, call to see if would be worthwhile for you.

More on the R&D Tax Credit

 

Exhibit 1. Four types of R&D tax credit qualifying research activities

rd-credit

The R&D credit is available to taxpayers who incur incremental expenses for qualified research activities (QRAs) conducted within the U.S. The credit is comprised primarily of the following qualified research expenses (QREs):

  1. Internal wages paid to employees for qualified services.
  2. Supplies used and consumed in the R&D process.
  3. Contract research expenses (when someone other than an employee of the taxpayer performs a QRA on behalf of the taxpayer, regardless of the success of the research). Many times supervisory efforts of senior scientists and owners are missed because those expenses do not reside in the traditional cost buckets.
  4. Basic research payments made to qualified educational institutions and various scientific research organizations.

Specific examples of qualifying activities include:

  1. Development of software that provides a computer service when customers are using the company’s computer or software technology.
  2. Design or development of any new software or technology products for commercial sale, lease, or license.
  3. Software developed as part of a hardware/software product (embedded software).
  4. Modification or improvement of an existing software or technology platform that significantly enhances performance, functionality, reliability, or quality.
  5. New architecture design.
  6. Integrating legacy applications and provisioning across virtual environments.
  7. Development of new communication and security protocols.
  8. Design of database management systems.
  9. IUS development.
  10. Developing software to improve planning capabilities as part of the supply chain process, including enhanced efficiencies and new functionality.
  11. Programming software source code.
  12. Advanced mathematical modeling.
  13. Research of specifications and requirements, domain, software elements including definition of scope and feasibility analysis for development or functional enhancements.
  14. Beta testing-logic, data integrity, performance, regression, integration, or compatibility testing.
  15. Optimization of code for product performance issues, new features, or integration with new platforms or operating systems.
  16. Research for development of applications for technology patents.
  17. Design of database backend.
  18. Developing financial analytics engines to improve forecast quality and coverage.
  19. Software development to improve system reliability and uptime and computer resource efficiency.
  20. Optimizing data access patterns.
  21. System architecture research to improve scalability, functionality, or improved performance.
  22. Software design to work with different databases.
  23. Rapid prototyping.
  24. Development related to performance issues such as systems running too slowly or bottlenecking.

For an activity to qualify for the research credit, the taxpayer must show that it meets the following four tests:  

  1. The activities must rely on a hard science, such as engineering, computer science, biological science, or physical science.
  2. The activities must relate to the development of new or improved functionality, performance, reliability, or quality features of a structure or component of a structure, including product or process designs that a firm develops for its clients.
  3. Technological uncertainty must exist at the outset of the activities. Uncertainty exists if the information available at the outset of the project does not establish the capability or methodology for developing or improving the business component, or the appropriate design of the business component.
  4. A process of experimentation (e.g., an iterative testing process) must be conducted to eliminate the technological uncertainty. This includes assessing a design through modeling or computational analysis.

Determining the true cost of R&D is often difficult because few firms have a project accounting system that captures many of the costs for support provided by the various personnel who collaborate on R&D. The typical project tracking system may not include contractor fees, direct support costs, and salaries of high-level personnel who participate in the research effort.

Appropriate documentation may require changes to a firm’s recordkeeping processes because the burden of proof regarding all R&D expenses claimed is on the taxpayer. The firm must maintain documentation to illustrate the nexus between QREs and QRAs. According to the IRS Audit Techniques Guide for the R&D credit, the documentation must be contemporaneous, meaning that it was created in the ordinary course of conducting the QRAs. Furthermore, a careful analysis should take place to evaluate whether expenses associated with eligible activities performed in the firm outside of the R&D department may have been missed and can be included in the R&D credit calculation. This is accomplished by interviewing personnel directly involved in R&D or those who are in support or supervision of R&D efforts.

Again, please feel free to contact me at don@kiplingerco.com to schedule an exploratory no cost, no obligation call to see if would be worthwhile for you.

Posted by Don James, CPA/CFP

2017 Personal Planning & Goal Setting


I am in the process of completing my 2017 personal strategic plan and want to pass on 15 questions which I find extremely helpful.  My planning has to do with setting personal goals for the year…which are birthed from my vision for my life…and tie directly into my financial plan.  These 15 questions help clarify that vision.

A lot has been written about setting goals. (Yes, it is that important.) Henry David Thoreau said, “If man advances competently in the direction of his dreams and he endeavors to live the life that he has imagined he will meet with success unexpected in common hours.”  This implies that you must have a dream.  You must endeavor to live the life that you have imagined.  Furthermore, when the dream is linked to purpose and values, there is an overwhelming incentive to pursue it.

What does all this have to do with financial planning?  Everything.  Purpose-driven living provides meaning and direction as to how we order our financial life.  When one has a clear understanding of his/her purpose and values, making decisions about money become noticeably easier.

There have been several studies illustrating the benefits of goal setting. The best-known study was done at Yale University way back in 1950’s. The researchers asked the Class of 1953 a number of questions. Three had to do with goals:

Have you set goals?

Have you written them down?

Do you have a plan to accomplish them?

As it turned out only 3 percent of the class had written down their goals, with a plan to achieve them.  Thirteen percent had goals, but had not written them down.  Fully 84% had no specific goals at all, other than to “enjoy themselves.”

In 1973, when the researchers resurveyed same class, the differences between the goal setters and everyone else were stunning. The 13 percent who had goals that were not in writing were earning, on average, twice as much as the 84% of students who had no goals at all. But, most surprising of all, the 3 percent who had written their goals down were earning, on average, ten times as much as the other 97 percent of graduates combined!

Goal setting is determined by your personal vision.  A personal vision is the deepest expression of what we want in life.  It is a description of our preferred future, not a prediction of what will be.  In this sense, your personal vision should describe what you want out of life and work and what kind of person you want to be.  Instead of a forecast of what you think might be likely in the future, your personal vision is a description of the future you dream about.

Here are the 15 questions that I discovered in Todd Duncan’s book “The Power to be Your Best” which are a great help in taking an inventory of where I am right now. I have found that they help me become more intentional about what I feel I must become to sense my true significance.

  1. Am I missing anything in my life right now that is important to me?  (What’s not happening that I want to happen?)
  1. What am I passionate about that gives meaning to life?
  1. Who am I, and why am I here?
  1. What do I value that gives real happiness?
  1. Where do I want to be and what do I want to be doing in 5 years?  10 years?  20 years?
  1. What gifts that God has given to me am I using effectively?  Which am I not using effectively?
  1. What is it that I believe so strongly in that I would be willing to die for?
  1. What is it about my job that makes me feel trapped?
  1. What realistic changes can I make in how I run my business so I can experience more freedom?
  1. What steps should I be taking now to ensure that the future is as meaningful as possible?
  1. With regard to money, how much is enough?   If I have more, what will the excess be used for?
  1. Am I living a balanced life?  Which areas are in need of time and focus?
  1. Where do I seek inspiration, mentors, and working models for greater significance?
  1. What do I want to be remembered for?
  1. What legacy do I want to leave for my children?

Consider your responses to all of the questions listed above as you reflect about your personal vision.  This may help you to identify the most important elements of your vision.

By Don James CPA/PFS, CFP

Importance of Updating Beneficiary Designations


Most of us have more than enough to do. We’re on the go from early in the morning until well into the evening—six or seven days a week. Thus, it’s no surprise that we may let some important things slide. We know we need to get to them, but it seems like they can just as easily wait until tomorrow or the next day or whenever.

A U.S. Supreme Court decision reminds us that sometimes “whenever” never gets here, and the results can sometimes be tragic. In this real life example, the ex-spouse collected $400,000 from Dad’s company savings and investment plan even though the ex had specifically waived any interest in the plan under the divorce agreement. Believing the divorce agreement was the last word on the subject, Dad failed to turn in the form to officially change the plan beneficiary from his ex to his daughter. He died seven years after the divorce. The company plan document stipulated that beneficiaries could only be changed by submitting the required form. The Supreme Court unanimously ruled that the beneficiary designation trumped the divorce agreement. So the ex got the $400,000. (We can only imagine that Dad was rolling over in his grave.)

The tragic outcome of this case was largely controlled by its unique facts. If the facts had been slightly different (such as the plan allowing a beneficiary to be designated on a document other than the plan’s beneficiary form), the outcome could have been quite different and a lot less tragic. However, it still would have taken a lot of effort and expense to get there. This leads us to a couple of important take away points.

The first is that if you want to change the beneficiary for a life insurance policy, retirement plan, IRA, or other benefit, use the plan’s official beneficiary form rather than depending on an indirect method such as a will or divorce decree. The second point is that it’s important to keep your beneficiary designations up-to-date. Whether it is because of divorce or some other life changing event, beneficiary designations made years ago can easily become outdated.

One final thought regarding beneficiary designations, while you’re verifying that all of your beneficiary designations are current, make sure you’ve also designated secondary beneficiaries where appropriate. This is especially important with assets such as IRAs, where naming both a primary and secondary beneficiary can potentially allow payouts from the account to be stretched out over a longer period and maximize the time available for the tax deferral benefits to accrue.

If you have any questions about what we’ve discussed in this letter, please contact us.

Posted by Don James, CPA, CFP

The Individual Mandate and Your 2014 Tax Return


Background

Beginning January 1, 2014, all individuals who do not meet certain exemption criteria must have minimum essential health insurance coverage. Nonexempt individuals who do not maintain the required health insurance coverage for themselves and any nonexempt dependents are subject to a shared responsibility penalty for each month that the required insurance is not maintained.  Generally, the individual mandate applies to U.S. citizens and permanent residents. Additionally, foreign nationals residing in the U.S. long enough during a calendar year to qualify as resident aliens for income tax purposes are subject to the mandate

Generally, individuals will obtain the required minimum essential coverage through an eligible employer-sponsored plan or through an individual plan purchased through a state insurance marketplace. Individuals qualifying for Medicare, Medicaid, CHIP, or certain other government sponsored programs are considered to have minimum essential coverage that satisfies the mandate.

A significant factor in determining if an individual (or family) is subject to the individual mandate is the individual’s household income. The IRS and The U.S. Department of Health and Human Services (HHS) have determined that for purposes of the individual mandate, the relevant household income is the income for the year for which the penalty is due (or an exemption from the mandate can be claimed). Of course, this generally means household income cannot be accurately determined for the penalty purposes until the individual files their income tax return.

Any individual whose household income for a tax year is below the gross income amount that requires them to file a federal income tax return is an exempt individual.  For individuals who can be claimed as a dependent on another person’s income tax return (e.g., children), the filing threshold of the person who can properly claim the individual as a dependent is used. Therefore, if an individual (e.g., parent) is exempt, any dependent (e.g., child) who can properly be claimed as a dependent for income tax purposes is also an exempt individual.

Beginning in 2014 all individuals who do not meet certain exemption criteria must have minimum essential health insurance coverage. For every month that the nonexempt individual (or that individual’s nonexempt dependents) does not have minimum essential coverage, a penalty is imposed. For taxpayers who file a joint return, the spouse is jointly liable for the penalty.

You can expect the fee for the preparation of your tax return to increase as a result of the preparer’s additional responsibility for determining and calculating (if required) the penalty.

Calculating the Individual Shared Responsibility Penalty

The individual shared responsibility penalty is the lesser of:

1.  the sum of the monthly penalty amounts for each individual in the shared responsibility family for months in the tax year during which one or more failures to maintain minimum essential coverage occurred,
A. The monthly penalty amount is an amount equal to one-twelfth of the greater of:

1)  a flat dollar amount – which is the lesser of:

a) the sum of the applicable dollar amounts ($95 for 2014, $325 for 2015, and $695 for 2016) for all individuals over age 18 (1/2 the amounts for dependents under age 18) included in the taxpayer’s shared responsibility family, or

b) 300% of the applicable dollar amount (determined without regard to the special rule for individuals under age 18 for the calendar year with or within which the tax year ends).

2)  an excess income amount that is based on a percentage of income.

a)  the excess income amount is the excess of the taxpayer’s household income for the tax year over a threshold gross income amount multiplied by the income percentage. The threshold gross income amount is the amount of income required for an individual to file an income tax return for a particular year.

b)  the income percentage is:

       i.  1% for tax years beginning in 2013 and 2014,

      ii.   2% for tax years beginning in 2015, and

     iii.  2.5% for tax years beginning in 2016 and later years.

2.  the sum of the monthly national average premium for bronze-level qualified health plans that provide coverage for the applicable shared responsibility family. (Generally, a bronze plan is one that pays for 60% of the value of the benefits provided under the plan. The individual is responsible for the other 40% of costs.)

Examples

1.    For 2014, Jim and Judy have $125,000 of household income. They are uninsured all year.  Assume the threshold filing amount for Married Filing Joint is $19,500.

The applicable income is: $105,500 ($125,000 – $19,500)

The Penalty is $1,055 which is the greater of:

(Flat dollar amount) $95 x 2 = $190

(Excess income) 1% x $105,500 = $1,055

2.    Joe and Joan are married with three dependents, two under age 18. No insurance in 2014. The household income is $120,000 and filing threshold is $24,000. National Average Bronze Plan  premium is $20,000.

Flat dollar amount ($95 x 3 + $95/2 x 2) = $380

Not to exceed the maximum amount ($95 x 300%) = $285

Excess income amount (120,000 – 24,000) x 1% = $960

Penalty = $960 (Greater of $285 or $960 but not more than $20,000)

3.    Same facts as Example 2 above except it is now 2016.

Flat dollar amount ($695 x 3 + $695/2 x 2) = $2,780

Not to exceed the maximum amount ($695 x 300%) = $2,085

Excess income amount (120,000 – 24,000) x 2.5% = $2,400

Penalty = $2,400 (Greater of $2,085 or $2,400 but not more than $20,000)

4.   Gerald is single with no dependents. During 2014 he has insurance Jan-June. His household income is $120,000 and filing threshold is $12,000. National Average Bronze Plan premium is $5,000.

Flat dollar amount ($95 x 6/12) $48

Not to exceed the maximum amount (1 x $95 x 6/12)= $48

Excess income amount (120,000 – 12,000) x 1.0% x 6/12 = $540

Penalty = $540 (Greater of $48 or $540 but not more than $2,500)

Insurers and employers will have new reporting requirements beginning in 2015. Information regarding an individual’s health insurance coverage will be reported to the IRS (and to the individual) using new information reporting Forms 1095-B and 1095-C. The IRS intends to use a matching process similar to the process used for matching interest or dividend income reported on an individual’s income tax return with the amount reported to the IRS by banks and other payers. If an individual is not reported as having insurance coverage or being exempt from the penalty and does not report and pay the penalty when filing his or her individual income tax return, the IRS will correspond with the individual.

Posted by Don James, CPA, CFP

Careful planning required for new ACA requirements on 2014 returns


The Affordable Care Act—enacted nearly five years ago—phased in many new requirements affecting individuals and employers. One of the most far-reaching requirements, the individual mandate, took effect this year and will be reported on 2014 income tax returns filed in 2015. The IRS is bracing for an avalanche of questions about taxpayer reporting on 2014 returns and, if liable, any shared responsibility payment. For many taxpayers, the best approach is to be familiar with the basics before beginning to prepare and file their returns.

Individual mandate

Beginning January 1, 2014, the Affordable Care Act requires individuals (and their dependents) to have minimum essential health care coverage or make a shared responsibility payment, unless exempt. This is commonly called the “individual mandate.”

Employer reporting

Nearly all employer-provided health coverage is treated as minimum essential coverage. This includes self-insured plans, COBRA coverage, and retiree coverage. Large employers will provide employees with new Form 1095-C, Employer-Provided Health Insurance Coverage and Offer, which will report the type of coverage provided. The IRS has encouraged employers to voluntarily report starting in 2015 for the 2014 plan year. Mandatory reporting begins in 2016 for the 2015 plan year.

Marketplace coverage

Coverage obtained through the Affordable Care Act Marketplace is also treated as minimum essential coverage. Marketplace enrollees should expect to receive new Form 1095-A, Health Insurance Marketplace Statement, from the Marketplace. Individuals with Marketplace coverage will indicate on their returns that they have minimum essential coverage. Because so many individuals with Marketplace coverage also qualify for a special tax credit, they will also likely need to complete new Form 8962, Premium Tax Credit (discussed below).

Medicare, Medicaid and other government coverage

Medicare, TRICARE, CHIP, Medicaid, and other government health programs are treated as minimum essential coverage. There are some very narrow exceptions but overall, most government-sponsored coverage is minimum essential coverage.

Exemptions

Some individuals are expressly exempt under the Affordable Care Act from making a shared responsibility payment. There are multiple categories of exemptions. They include:

  • Short coverage gap
  • Religious conscience
  • Federally-recognized Native American nation
  • Income below income tax return filing requirement

The short coverage gap applies to individuals who lacked minimum essential coverage for less than three consecutive months during 2014. They will not be responsible for making a shared responsibility payment. Individuals who are members of a religious organization recognized as conscientiously opposed to accepting insurance benefits also are exempt from the individual mandate. Similarly, members of a federally-recognized Native American nation are exempt. If a taxpayer’s income is below the minimum threshold for filing a return, he or she is exempt from making a shared responsibility payment.

The IRS has developed new Form 8965, Health Coverage Exemptions. Taxpayers exempt from the individual mandate will file Form 8965 with their federal income tax return.

Shared responsibility payment

All other individuals – individuals without minimum essential coverage and who are not exempt – must make a shared responsibility payment when they file their 2014 return. For 2014, the payment amount is the greater of: One percent of the person’s household income that is above the tax return threshold for their filing status; or a flat dollar amount, which is $95 per adult and $47.50 per child, limited to a maximum of $285. The individual shared responsibility payment is capped at the cost of the national average premium for the bronze level health plan available through the Marketplace in 2014. Taxpayers will report the amount of their individual shared responsibility payment on their 2014 Form 1040.

The IRS has cautioned that it will offset a taxpayer’s refund if he or she fails to make a shared responsibility payment if required. However, the Affordable Care Act prevents the IRS from using its lien and levy authority to collect an unpaid shared responsibility payment.

Code Sec. 36B credit

Only individuals who obtain coverage through the Marketplace are eligible for the Code Sec. 36B premium assistance tax credit. The U.S. Department of Health and Human Services (HHS) has reported that more than two-thirds of Marketplace enrollees are eligible for the credit and many enrollees have received advance payment of the credit.

All advance payments of the credit must be reconciled on new Form 8962, which will be filed with the taxpayer’s income tax return. Taxpayers will calculate the actual credit they qualified for based on their actual 2014 income. If the actual premium tax credit is larger than the sum of advance payments made during the year, the individual will be entitled to an additional credit amount. If the actual credit is smaller than the sum of the advance payments, the individual’s refund will be reduced or the amount of tax owed will be increased, subject to a sliding scale of income-based repayment caps.

A change in circumstance, such as marriage or the birth/adoption of a child, could increase or decrease the amount of the credit. Individuals who are receiving an advance payment of the credit should notify the Marketplace of any life changes so the amount of the advance payment can be adjusted if necessary. Please contact our office if you have any questions about the Code Sec. 36B credit.

Posted by Don James, CPA, CFP

An Overview of the New Tangible Property Regulations


The IRS issued new regulations for determining whether amounts paid to acquire, produce, or improve tangible property may be currently deducted as business expenses or must be capitalized. Among other things, they provide detailed definitions of “materials and supplies” and “rotable and temporary spare parts” and prescribe rules and elective de minimis and optional methods for handling their cost. They also have rules for differentiating between deductible repairs and capitalizable improvements, among many other items. The regulations generally are effective for tax years beginning on or after Jan. 1, 2014.

For decades, the regulations under § 162 provided that (1) the cost of incidental repairs that neither materially increase the value of the property nor appreciably prolong its useful life, but simply keep it in an ordinarily efficient operating condition, may be deducted as business expenses, provided the basis of the property is not increased by the amount expended, but that (2) repairs in the nature of replacements, to the extent that they arrest deterioration and appreciably prolong the property’s life, must be capitalized and depreciated. The regulations under § 263 similarly distinguished between “incidental repairs” and capital expenditures that add to the value of or substantially prolong the useful life of property or adapt it to a new or different use.

In a December 2011 Treasury Decision, the Treasury Department criticized the vagueness of the rules for distinguishing repairs from capital expenditures: “The standards…set forth in the regulations, case law, and administrative guidance are difficult to discern and apply in practice, and have led to considerable uncertainty and controversy for taxpayers.” In the hopes of drawing a sharper line between deductible repairs and capital expenditures, the Treasury replaced the prior repair regulations with a much more elaborate set of temporary regulations. In September 2013, most of the temporary regulations were finalized.

These regulations are massive and will impact any business no matter its size, industry, or type of entity that acquires, produces, maintains, or improves tangible property, which is virtually all businesses. We will attempt to highlight changes that impact small businesses.

Materials and supplies

As stated earlier, businesses must generally capitalize expenditures relating to tangible property. Materials and supplies used to improve tangible property must generally be capitalized under the rules for improvements. Other materials and supplies can be deducted as follows:

  • Incidental Materials and Supplies —can be deducted in the year they are paid (or, incurred for accrual taxpayers). Material and supplies are incidental if they are carried on hand and no record of consumption is kept or physical inventories maintained. However, immediate deduction is allowed only if it clearly reflects income.
  • Nonincidental Materials and Supplies —are deducted in the year they are used or consumed in the taxpayer’s business operations. (This is referred to as the consumption method.)

Materials and supplies include any item of tangible property used or consumed in the taxpayer’s operations that is not inventory and is included in one of the following categories:

  1. A component acquired to maintain, repair, or improve a unit of tangible property that is not acquired as part of any single unit of tangible property.
  2. Fuel, lubricants, water, and similar items, that are reasonably expected to be consumed in 12 months or less, beginning when used in taxpayer’s operations.
  3. A unit of property that has an economic useful life of 12 months or less, beginning when the property is used or consumed in the taxpayer’s operations. The economic useful life is generally the period over which the property may reasonably be expected to be useful to the taxpayer considering the wear and tear, climatic, and other conditions particular to the taxpayer’s business
  4. A unit of property that has an acquisition or production cost (as determined under Section 263A) of $100 or less. (We’ll call this the de minimis qualification rule.)
  5. An item identified in future published IRS guidance as materials and supplies.

The general rule is that materials and supplies (as just defined) that are not used to improve tangible property are deductible when paid (or incurred) if they are incidental or when consumed if they are non-incidental. This is substantially the same rule that applied before the new regulations were issued.

Repairs verses Improvements

Expenditures related to tangible property must be capitalized if they are for permanent improvements or betterments that increase the property’s value or that restore its value or make good the exhaustion thereof for which an allowance has been made. On the other hand, expenses for repairs and maintenance to tangible property that are not otherwise required to be capitalized under Section 263 or any other Code section can be expensed.

The regulations require taxpayers to capitalize amounts paid to improve a unit of property. A unit of property is improved if the cost results in (1) a betterment (2) a restoration, or (3) an adaptation to a new or different use of the unit of property.

A unit of property is an essential term in the temporary regulations, as taxpayers must apply the improvement standards to the unit of property. The temporary regulations provide two definitions—one for buildings and another for property other than buildings.

Building and Structural Components

For buildings, a unit of property consists of the building and its structural components other than the components specifically listed as building systems. Building systems include the following:

  • Heating, ventilation, and air conditioning systems (“HVAC”).
  • Plumbing systems.
  • Electrical systems.
  • All escalators.
  • All elevators.
  • Fire protection and alarm systems.
  • Security systems.
  • Gas distribution systems.
  • Any other systems identified in published guidance.

A cost must be capitalized if it results in an improvement to (1) the building structure or (2) any of the specifically enumerated building systems. This is a significant change from the old regulations, which defined the unit of property as simply the building and its structural components and required capitalization only if a cost resulted in an improvement when applied to the building and its structural components as a whole. Under those rules, costs incurred for work performed on a component part of a building (such as an escalator or HVAC system) were often currently deductible as repairs because they didn’t improve the building as a whole. The broad definition of a unit of property for buildings and building systems requires the capitalization of improvements that previously may have been expensed as repair costs.

On the flip side, the new regulations now define dispositions to include the retirement of a structural component of a building. This change allows the adjusted basis of the structural component to be written off on its disposition. Previously, the retirement of a structural component of a building was not considered a disposition. Therefore, the retired component’s adjusted basis could not be immediately written off as long as the building was still being depreciated. Instead it had to continue to be depreciated as part of the building, even though it no longer existed.

Betterment of unit of property – Costs that result in the betterment to a unit of property must be capitalized. There is a betterment when the cost (1) ameliorates a material condition or defect that existed before the taxpayer acquired the property, or arose during the production of the property; (2) results in a material addition to the property; or (3) results in a material increase in capacity, productivity, efficiency, strength, quality, or output of the property.

All of the relevant facts and circumstances must be considered when determining whether an amount paid results in a betterment, including the purpose of the expenditure, the physical nature of the work performed, the effect of the expenditure on the unit of property.

Property Other Than Buildings

For property other than buildings, a unit of property consists of all components (real or personal property) that are functionally interdependent to one another. Generally, functionally interdependent denotes components that must be placed in service together at the same time in order to perform their intended function. For example, a computer and printer would not be functionally interdependent since either could be placed in service separately and function independently. Various components of a piece of equipment would be functionally interdependent.

Observation: The smaller the unit of property, the more likely a component part would materially add to the value of the property and prolong its useful life and therefore need to be capitalized. The larger the unit of property, the more likely the exchange or addition of a component part would be incidental to the unit of property and, therefore, currently deductible.

Safe Harbor for Routine Maintenance on Property Other Than Buildings – The temporary regulations provide a safe harbor for the cost of routine maintenance performed on a unit of property (other than to a building or its structural components) including inspection, cleaning, testing, replacement of parts, and other recurring activities performed to keep a unit of property in its ordinary efficient operating condition.

Activities are routine only if they are reasonably expected to be performed by the taxpayer more than once during the life of the unit of property and do not improve the unit of property. Factors to consider in making this determination include industry practice, manufacturers’ recommendations, taxpayer’s experiences, and treatment of the activity on the taxpayer’s AFS. Routine maintenance does not include any of the following:

  1. Amounts paid to replace a component of a unit of property if the taxpayer has properly deducted a loss for that component (other than a casualty loss under or taken into account the component’s adjusted basis in realizing gain or loss from the sale or exchange of the component.
  2. Amounts paid to repair damage to a unit of property for which the taxpayer has taken a basis adjustment as a result of a casualty loss or relating to a casualty event described in IRC Sec. 165.
  3. Amounts paid to return a unit of property to its ordinarily efficient operating condition if the property has deteriorated to a state of disrepair and is no longer functional for its intended use.
  4. Amounts paid for repairs, maintenance, or improvement of rotable and temporary spare parts for which the taxpayer applies the spare-parts-optional method.

Filing Form 3115

Changes to comply with the preceding provisions addressed in the regulations (i.e., amounts paid to improve tangible property, determining the appropriate unit of property, betterments to a unit of property, amounts paid to restore a unit of property, and amounts paid to adapt a unit of property to a new or different use) are changes in accounting methods that require IRS consent.

Rev. Proc. 2012-19 supplies procedures for requesting automatic IRS consent for changes other than changes related to the treatment of building structural component dispositions. This will entail filing Form 3115 (Application for Change in Accounting Method) with the taxpayer’s tax return for the year of the change and computing a Section 481(a) adjustment. The Section 481(a) adjustment must be calculated using only amounts paid or incurred in taxable years beginning after 2011. A copy of the Form 3115 is also filed with the IRS in Ogden, Utah.

These are only some of the highlights of the tangible property regulations that impact small businesses. These regulations are massive and filled with numerous examples.

By Don James, CPA/PFS, CFP

IRS scandal – TIGTA audit finds no high-level political Shenanigans


All the media and Congressional speculation regarding possible involvement by the current administration in the recent IRS scandal has been significantly alleviated by the May 14, 2013 report issued by the Treasury Inspector General for Tax Administration (TIGTA). Their report concluded that inappropriate criteria were used to identify tax-exempt applications for review due to ineffective management and lack of training of lower-level IRS staff members in the Exempt Organization office.

Here is how it began. During the 2012 election cycle, some members of Congress raised concerns to the IRS about selective enforcement and the duty to treat similarly situated organizations consistently. In addition, several organizations applying for I.R.C. § 501(c)(4) tax-exempt status made allegations that the IRS 1) targeted specific groups applying for tax-exempt status, 2) delayed the processing of targeted groups’ applications for tax-exempt status, and 3) requested unnecessary information from targeted organizations. As a result of the concerns expressed by Congress, TIGTA was asked to investigate the IRS handling of these issues.

Organizations, such as charities, seeking Federal tax exemption are required to file an application with the Internal Revenue Service (IRS). Other organizations, such as social welfare organizations, may file an application but are not required to do so. The IRS’s Exempt Organizations (EO) function, Rulings and Agreements office, which is headquartered in Washington, D.C., is responsible for processing applications for tax exemption. Within the Rulings and Agreements office, the Determinations Unit in Cincinnati, Ohio, is responsible for reviewing applications as they are received to determine whether the organization qualifies for tax-exempt status.

Most organizations requesting tax-exempt status must submit either a Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code, or Form 1024, Application for Recognition of Exemption Under Section 501(a), depending on the type of tax-exempt organization it desires to be. For example, a charitable organization would request exemption under Internal Revenue Code (I.R.C.) Section (§) 501(c)(3), whereas a social welfare organization would request exemption under I.R.C. § 501(c)(4).

The I.R.C. section and subsection an organization is granted tax exemption under affects the activities it may undertake. For example, I.R.C. § 501(c)(3) charitable organizations are prohibited from directly or indirectly participating in or intervening in any political campaign on behalf of or in opposition to any candidate for public office (hereafter referred to as political campaign intervention).  However, I.R.C. § 501(c)(4) social welfare organizations, I.R.C. § 501(c)(5) agricultural and labor organizations, and I.R.C. § 501(c)(6) business leagues may engage in limited political campaign intervention.

An organization engages in general advocacy when it attempts to 1) influence public opinion on issues germane to the organization’s tax-exempt purposes, 2) influence nonlegislative governing bodies (e.g., the executive branch or regulatory agencies), or 3) encourage voter participation through “get out the vote” drives, voter guides, and candidate debates in a nonpartisan, neutral manner. General advocacy basically includes all types of advocacy other than political campaign intervention and lobbying.

TIGTA found that:

1.   IRS developed and began using criteria to identify potential political cases for review that inappropriately identified specific groups applying for tax-exempt status based on their names (Tea Party, Patriots, or 9/12 in the organization’s name as well as other “political-sounding” names), or policy positions instead of developing criteria based on tax-exempt laws and Treasury Regulations. However, after being briefed on the expanded criteria in June 2011, the Director of EO immediately directed that the criteria be changed. In July 2011, the criteria were changed to focus on the potential “political, lobbying, or [general] advocacy” activities of the organization. These criteria were an improvement over using organization names and policy positions. However, the team of specialists subsequently changed the criteria in January 2012 without executive approval because they believed the July 2011 criteria were too broad. The January 2012 criteria again focused on the policy positions of organizations instead of tax-exempt laws and Treasury Regulations. After three months, the Director, Rulings and Agreements, learned the criteria had been changed by the team of specialists and subsequently revised the criteria again in May 2012. The May 2012 criteria more clearly focus on activities permitted under the Treasury Regulations.

2.   Potential political cases took significantly longer than average to process due to ineffective management oversight. Once cases were initially identified for processing by the team of specialists, the Determinations Unit Program Manager requested assistance via e-mail from the Technical Unit to ensure consistency in processing the cases. However, EO function management did not ensure that there was a formal process in place for initiating, tracking, or monitoring requests for assistance. In addition, there were several changes in Rulings and Agreements management responsible for overseeing the fulfillment of requests for assistance from the Determinations Unit during this time period. This contributed to the lengthy delays in processing potential political cases. As a result, the Determinations Unit waited more than 20 months (February 2010 to November 2011) to receive draft written guidance from the Technical Unit for processing potential political cases.

3.   The IRS sent requests for information that TIGTA (in whole or in part) determined to be unnecessary for 98 (58 percent) of 170 organizations that received additional information request letters.  According to the Internal Revenue Manual, these requests should be thorough, complete, and relevant. However, the Determinations Unit requested irrelevant (unnecessary) information because of a lack of managerial review, at all levels, of questions before they were sent to organizations seeking tax-exempt status. We also believe that Determinations Unit specialists lacked knowledge of what activities are allowed by I.R.C. § 501(c)(3) and I.R.C. § 501(c)(4) tax-exempt organizations. This created burden on the organizations that were required to gather and forward information that was not needed by the Determinations Unit and led to delays in processing the applications. These delays could result in potential donors and grantors being reluctant to provide donations or grants to organizations applying for I.R.C. § 501(c)(3) tax-exempt status. In addition, some organizations may not have begun conducting planned charitable or social welfare work.

TIGTA asked the Acting Commissioner, Tax Exempt and Government Entities Division; the Director, EO; and Determinations Unit personnel if the criteria were influenced by any individual or organization outside the IRS. All of these officials stated that the criteria were not influenced by any individual or organization outside the IRS. Instead, the Determinations Unit developed and implemented inappropriate criteria in part due to insufficient oversight provided by management. Specifically, only first-line management approved references to the Tea Party in the criteria listing before it was implemented. As a result, inappropriate criteria remained in place for more than 18 months. Determinations Unit employees also did not consider the public perception of using politically sensitive criteria when identifying these cases. Lastly, the criteria developed showed a lack of knowledge in the Determinations Unit of what activities are allowed by I.R.C. § 501(c)(3) and I.R.C. § 501(c)(4) organizations.

As Lynn Nichols, CPA points out in the Ohio Society of CPAs Tax Section LinkedIn site, more evidence of IRS abuse of power and institutional arrogance continues to come to light, and abuses are not limited to the Exempt Organization division.  In Anonymous 1 et al. v. Commissioner; US Tax Court order; No. 12472-11W 5/10/2013, the IRS was found to have lied to the Court about whether it used information from whistleblowers to initiate an audit that produced tax liability of hundreds of millions. In another, less widely publicized incident, IRS agents serving a search warrant for information about a one of a corporation’s employees improperly demanded the full contents of the company’s servers. Those records included medical records of over 10 million individuals that are protected from disclosure by HIPPA rules. The IRS agents threatened to “pull the servers out of the wall” in spite of being warned that the records they contained were protected by statute and NOT COVERED BY THE WARRANT. (John Doe Co. et al. v. John Does 1-15; No. 37-2013-00038750; SUPERIOR COURT OF THE STATE OF CALIFORNIA FOR SAN DIEGO (3/11/2013))

You can find the complete TIGTA report at: http://www.treasury.gov/tigta/auditreports/2013reports/201310053fr.pdf

By Don James, CPA/PFS, CFP

Musings on minimizing taxes on investments


During 2012, one of my clients generated $50,000 of short-term capital gains by taking advantage of short-term swings in the market. That was quite an accomplishment!  However, since they pay tax of 33% (28% federal plus 5% state) on short-term gains, their tax bill on the gain amounted to $16,500. That is still a net gain of $33,500 ($50,000-16,500) after taxes…which is nothing to sneeze at!  But, as I pointed out to them, if they were to do that inside their traditional IRA, the $16,500 paid in taxes would still be in their IRA working for them.

Their question to me was “What if we incur losses? We cannot deduct those losses in our IRA. Is this still a good idea?”  Personally, I think moving investments that produce short-term capital gains into an IRA (and off your annual income tax return) is a great idea. However, it is not a great place for losses…but neither is your non-retirement investment account.

Let’s assume the worse…the market suddenly tanks and you incur $60,000 of losses before you can convert everything to cash. If the losses occur in your non-retirement account you would be able to offset $3,000 of those losses against your other income each year. You would also be able to offset future capital gains (long-term and short-term). However, if the losses occur in your IRA, there is no $3,000/year deduction available. But, if you never recoup those losses, you obviously will never be taxed on the vanished $60,000. On the other hand, if you recoup the $60,000 via short-term gains in your IRA, it is not taxed until you decide to withdraw it during retirement. Bottom line…by moving investments generating short-term capital gains into your IRA, you are foregoing the opportunity to recoup $1,000  in taxes ($3,000 x 33% tax bracket) for losses in order to benefit from tax deferred growth on taxes paid on short-term capital gains ($16,500 in 2012).

Consider for moment that there is no such thing as long-term capital gains or qualified dividends (taxed at 15-23.8% if held in a non-retirement account) in an IRA. When distributed, all income is taxed at ordinary tax rates.

Thus, when allocating your assets from a tax perspective, in a perfect world, your non-retirement accounts generate qualified dividends and long-term capital gains and tax-exempt interest. Your IRA investments generate short-term capital gains, nonqualified dividends and interest income (all taxed at ordinary tax rates if held in a non-retirement account).

One last thought…if the $50,000 short-term capital gain had incurred inside a Roth IRA…the tax consequences of the taxes saved (including tax deferred growth) when later distributed…zero!

By Don James, CPA, CFP

There is more to qualifying as a dependent than “Who’s your daddy?”


“Who’s your daddy?” may be commonly used as a boastful claim of dominance over the another person, but it doesn’t always carry weight with the IRS when it comes to qualifying as a dependent. I have already seen a couple situations this year where the taxpayer has provided well over one-half of the support for another person, but still did not meet all the tests for claiming that person as a dependent.

Taxpayers can claim personal exemptions on their tax returns for themselves, their spouses, and dependents under IRC Sec. 151. Certain tests must be met to claim a person as a dependent. Exemption amounts are adjusted annually for inflation; the exemption amount for 2012 is $3,800. A dependency exemption deduction is available for each person who is a dependent of the taxpayer for the year. A dependent is defined as either a qualifying child or a qualifying relative.

Qualifying Child

A qualifying child is one who meets the following five tests:

1. Relationship,

2. Age,

3. Residency,

4. Support, and

5. Tie-breaker test for qualifying child of more than one person.

Relationship Test – The child must be the taxpayer’s:

  • Son, daughter, stepchild, eligible foster child or a descendant of any of them (for example, grandchild), or Brother, sister, half-brother, half-sister, stepbrother, stepsister or a descendant of any of them (for example, niece or nephew).
  • Adopted Child. An individual legally adopted by the taxpayer or an individual lawfully placed with the taxpayer for legal adoption is treated as a child by blood.
  • Eligible Foster Child. An eligible foster child is one placed with the taxpayer by an authorized placement agency or by judgment, decree or other order of any court of competent jurisdiction and is treated as the taxpayer’s child.

Age Test – The child:

  • Must be either:
    • Under age 19 at the end of the year, or
    • Under age 24 at the end of the year and a full-time student. A full-time student is one who is enrolled full-time in school (but not online or correspondence schools) during some part of any five months of the calendar year or is pursuing a full-time course of institutional on-farm training under the supervision of an accredited agency. In Letter Rul. 9838027, the IRS allowed the taxpayer to count the month of August when a student registered on August 28 but did not start classes until September 2.
  • Can be any age if totally and permanently disabled.

Caution: The age test differs slightly when determining if a child is a qualifying child for the dependent care credit (must be under age 13 if not disabled) and the child tax credit (must be under age 17).

Residency Test – The child must have the same principal residence as the taxpayer for more than half of the tax year. Temporary absences due to special circumstances, including absences due to illness, education, business, vacation or military service, are ignored.

Support Test – The child cannot provide over half of his or her own support. A full-time student does not take into account taxable or nontaxable scholarship payments received in calculating the support test.

Tie-breaker Rules—Qualifying Child of more than one Person – It’s possible that a child is the qualifying child of more than one person. If that occurs, the taxpayers can decide between themselves who will claim the qualifying child as a dependent. If they cannot agree and more than one person files a return claiming the same child, the tie-breaker rules apply to determine which taxpayer the IRS will allow to claim the child. The tie-breaker rules are summarized in the following table.

Qualifying Child—Tie-breaker Rules

IF more than one person files a return

claiming the same qualifying child and …

THEN, the child is treated as the

qualifying child of the…

only one of them is the child’s parent, parent.
two of them are the child’s parents and they

do not file a joint return,

parent with whom the child lived the greater portion of the year.
same as above but the child lived with each

parent for the same amount of time during

the year,

parent with the highest adjusted gross   income (AGI).
none of them is the child’s parent, person with the highest AGI.

Qualifying Relative

Individuals who do not meet the tests for being a qualifying child of the taxpayer may still qualify as a dependent of the taxpayer as a qualifying relative. A qualifying relative is a person who is not a qualifying child of anyone else and who also meets the following three tests with respect to the taxpayer:

1. Member of household or relationship,

2. Gross income, and

3. Support.

Unlike a qualifying child, a qualifying relative can be any age.

Member of Household or Relationship Test.

The person must:

1. Live in the taxpayer’s household for the entire year, or

2. Be related to the taxpayer in any of the following ways:

  • Child, stepchild, eligible foster child, grandchild or great grandchild
  • Brother, sister, half-brother, half-sister, stepbrother or stepsister
  • Father, mother, grandparent or other direct ancestor (but not foster parent)
  • Stepfather or stepmother
  • Niece or nephew
  • Aunt or uncle
  • Brother-in-law, sister-in-law, father-in-law, mother-in-law, son-in-law or daughter-in law

Related persons do not need to be members of the taxpayer’s household. Also, relationships established by marriage are not ended by death or divorce.

A person who died during the year and was a member of the household until death meets the member of household test. A child who was born and died during the year meets the member of household test. A person does not meet the member of household test if at any time during the tax year the taxpayer’s relationship with the person is in violation of local law.

Gross Income Test – The person must have less than $3,800 of gross income in 2012. Gross income includes:

  • All taxable income in the form of money, property or services.
  • Gross receipts from rental property (do not reduce for taxes, repairs and other deductions).
  • For a Schedule C business, net sales minus cost of goods sold plus miscellaneous business income.
  • A partner’s share of the gross (not net) partnership income.
  • Unemployment compensation and taxable scholarships and fellowship grants.

Gross income does not include:

  • Tax-exempt income (certain social security benefits, municipal bond interest, some scholarship benefits, etc.).
  • Income earned by a totally and permanently disabled person at a sheltered workshop operated by a tax-exempt organization or government agency that provides special instruction to alleviate the disability. To be excluded, the income must be incidental to medical care and must come solely from activities at the workshop.

Support test – The support test is met if:

1. The taxpayer provided over 50% of the person’s total support for the year, or

2. No one person provided more than 50% of the person’s total support but two or more persons collectively did. The person must be a member of the household or related to each contributor whose support is counted as shared support and must pass the other dependency tests. The exemption can be claimed by any contributor who provided more than 10% of total support. Those sharing support must agree which of them will claim the exemption. Form 2120 (Multiple Support Declaration) must be signed by all contributors and filed with the claimant’s tax return.

By Don James, CPA, CFP

Strategic Planning Terminology for Small Businesses


Most of what we learn in business schools and textbooks is written for large companies. There are many justifiable reasons for this. Jim Collins says that he studies large public companies simply because there is not enough information available for smaller private ones.  However, big or small, there is probably nothing in business more valuable than good strategic planning.

A critical first step in the planning process is articulating the purpose for your business, identifying your core values and developing a vision of the future. This post is about understanding the terminology of these elements which are vital to the rest of the strategic planning process.

Purpose

Your purpose is your businesses fundamental reason for existence beyond just making money. It is a perpetual star on the horizon and is not to be confused with specific goals or business strategies. It answers the question “why are we here?” A purpose is broad, fundamental, and enduring.  A good purpose should serve to guide and inspire for 100+ years.

Purpose need not be wholly unique…rather its role is to guide and inspire…not necessarily differentiate. There have been numerous studies and surveys of employees that have concluded that involvement in meaningful work is actually a more important factor than pay. Meaningful work is what gets business owners, and employees, out of bed in the morning.

Sample core purposes

  • Merck: To preserve and improve human life
  • Walt Disney: To make people happy
  • Sony: To experience the joy of advancing and applying technology for the benefit of the public

Values

Values govern the operation of the business and its conduct or relationships with society at large, customers, suppliers, employees, local community and other stakeholders. Values answer the questions “What do we want to live by?” and “How?” They need to be clearly described, so you know exactly the behaviors that demonstrate that the value is being lived. They are learned and reveled internal governors of right and wrong that we feel in our gut and throat. They help us choose what is most important.

Core values are a small set of general guiding principles:

  1. They are not to be confused with specific cultural or operational practices.
  2. They are not to be compromised for financial gain or short-term expediency.
  3. They are the organization’s essential and enduring tenants…never to be compromised.
  4. The real difference between success and failure in a business can be traced to how well the organization brings out the great energies and talents of it’s people.
  5. It sustains this common cause and sense of direction through many changes which take place from one generation to another. (It is the stake in the ground that keeps everyone from veering too far off course.)
  6. In most cases it can be boiled down to a piercing simplicity that provides substantial guidance.
  7. Visionary companies have between 3-6 core values. (Any more than 6 and you begin drifting away from those that are core.)

Sample core values

Merck:

  • Corporate social responsibility
  • Unequivocal excellence in all aspects of the company
  • Science-based innovation
  • Honesty and integrity
  • Profit, but profit from work that benefits humanity

Walt Disney:

  • No cynicism
  • Nurturing and promulgation of “wholesome American values”
  • Creativity, dreams, and imagination
  • Fanatical attention to consistency and detail
  • Preservation and control of the Disney magic

Sony:

  • Elevation of the Japanese culture and national status
  • Being a pioneer – not following others; doing the impossible
  • Encouraging individual ability and creativity

Vision

Vision should be presented as a pen picture of the business in five to seven years time in terms of its likely physical appearance, size, activities etc. Vision answers the question, “Where are we going?” It is the picture of the end result…something you can actually see…not vague. Vision is knowing who you are, where you are going, and what will guide your journey.

Vision and direction are essential for greatness. In world-class organizations, every-one has a clear sense of where the enterprise is going. Only when the leaders of an organization know that their people understand the agreed-upon vision and direction can they attend to strengthening the organization’s ability to deliver on this vision.

Vision helps people make smart choices because their decisions are being made with the end result in mind. As goals are accomplished, the answer to “What next?” becomes clear. Vision takes into account a larger picture than the immediate goal. Martin Luther King Jr. described his vision of a world where people live together in mutual respect. In his “I Have a Dream” speech, he described a world where his children “will not be judged by the color of their skin, but by the content of their character.” He created powerful and specific images from the values of brotherhood, respect, and freedom for all—values that resonate with the founding values of the United States. King’s vision has passed a crucial test – it continues to mobilize and guide people beyond his lifetime. Vision allows for a long-term proactive stance—creating what we want—rather than a short-term reactive stance—getting rid of what we don’t want.

Vision is important for leaders because leadership is about going somewhere. If you and your people don’t know where you are going, your leadership doesn’t matter. Without a clear vision, an organization becomes a self-serving bureaucracy.  The top managers begin to think “the sheep are there for the benefit of the shepherd.” All the money, recognition, power, and status move up the hierarchy, away from the people closest to the customers, and leadership begins to serve the leaders and not the organization’s larger purpose and goals. The results of this type of behavior have been all too evident recently at Enron, World-com, and other companies. Once the vision is clarified and shared, the leader can focus on serving and being responsive to the needs of the people. The greatest leaders have mobilized others by coalescing people around a shared vision. Sometimes leaders don’t get it at first, but the great ones eventually do.

Tests of a compelling vision are:

  1. Helps you understand what business you’re really in.
  2. Provides guidelines that help you make daily decisions.
  3. Provides a picture of the desired future that you can actually see.
  4. Is enduring
  5. Is about being great – not solely about beating the competition.
  6. Is inspiring – not expressed solely in numbers.
  7. Touches the hearts and spirits of everyone.
  8. Helps each team member see how he/she can contribute.

Parting thoughts

Jim Collins raises the question, “How can we be sure the core ideologies of highly visionary companies represent more than just a bunch of nice-sounding platitudes – words with no bite, words meant merely to pacify, manipulate, or mislead?” He then offers an answer. Social psychology research strongly indicates that when people publicly espouse a particular point of view, they become more likely to behave consistent with that point of view even if they did not previously hold that point of view. In other words, the very act of stating a core ideology influences behavior toward consistency with that ideology.

By Don James CPA/PFS, CFP

Personal Strategic Planning – 15 Questions to Clarify Your Vision


This post is a little different than my usual post.  Most of my posts have had to do with taxes.  However, I am in the process of completing my 2013 personal strategic plan and want to pass on 15 questions that I find extremely helpful.  My planning has to do with setting personal goals for the year…which are birthed from my vision for my life…and tie directly into my financial plan.  These 15 questions help clarify that vision.

A lot has been written about setting goals. (Yes, it is that important.) Henry David Thoreau said, “If man advances competently in the direction of his dreams and he endeavors to live the life that he has imagined he will meet with success unexpected in common hours.”  This implies that you must have a dream.  You must endeavor to live the life that you have imagined.  Furthermore, when the dream is linked to purpose and values, there is an overwhelming incentive to pursue it.

What does all this have to do with financial planning?  Everything.  Purpose-driven living provides meaning and direction as to how we order our financial life.  When one has a clear understanding of his/her purpose and values, making decisions about money become noticeably easier.

There have been several studies illustrating the benefits of goal setting. The best-known study was done at Yale University way back in 1950’s. The researchers asked the Class of 1953 a number of questions. Three had to do with goals:

Have you set goals?

Have you written them down?

Do you have a plan to accomplish them?

As it turned out only 3 percent of the class had written down their goals, with a plan to achieve them.  Thirteen percent had goals, but had not written them down.  Fully 84% had no specific goals at all, other than to “enjoy themselves.”

In 1973, when the researchers resurveyed same class, the differences between the goal setters and everyone else were stunning. The 13 percent who had goals that were not in writing were earning, on average, twice as much as the 84% of students who had no goals at all. But, most surprising of all, the 3 percent who had written their goals down were earning, on average, ten times as much as the other 97 percent of graduates combined!

Goal setting is determined by your personal vision.  A personal vision is the deepest expression of what we want in life.  It is a description of our preferred future, not a prediction of what will be.  In this sense, your personal vision should describe what you want out of life and work and what kind of person you want to be.  Instead of a forecast of what you think might be likely in the future, your personal vision is a description of the future you dream about.

I utilize a few tools to help shape my goal setting. The 15 questions below that I discovered in Todd Duncan’s book “The Power to be Your Best” is a great help for taking an inventory of where I am right now. I have found that they help me become more intentional about what I feel I must become to sense my true significance.

  1. Am I missing anything in my life right now that is important to me?  (What’s not happening that I want to happen?)
  1. What am I passionate about that gives meaning to life?
  1. Who am I, and why am I here?
  1. What do I value that gives real happiness?
  1. Where do I want to be and what do I want to be doing in 5 years?

10 years?

20 years?

  1. What gifts that God has given to me am I using effectively?  Which am I not using effectively?
  1. What is it that I believe so strongly in that I would be willing to die for?
  1. What is it about my job that makes me feel trapped?
  1. What realistic changes can I make in how I run my business so I can experience more freedom?
  1. What steps should I be taking now to ensure that the future is as meaningful as possible?
  1. With regard to money, how much is enough?   If I have more, what will the excess be used for?
  1. Am I living a balanced life?  Which areas are in need of time and focus?
  1. Where do I seek inspiration, mentors, and working models for greater significance?
  1. What do I want to be remembered for?
  1. What legacy do I want to leave for my children?

Consider your responses to all of the questions listed above as you reflect about your personal vision.  This may help you to identify the most important elements of your vision.

By Don James CPA/PFS, CFP

American Taxpayer Relief Act of 2012


The American Taxpayer Relief Act, with some modifications targeting the wealthiest Americans with higher taxes, the act permanently extends provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16 (EGTRRA), and Jobs and Growth Tax Relief Reconciliation Act of 2003, P.L. 108-27 (JGTRRA). It also permanently takes care of Congress’s perennial job of “patching” the alternative minimum tax (AMT). It temporarily extends many other tax provisions that had lapsed at midnight on Dec. 31 and others that had expired a year earlier.

The act’s nontax features include one-year extensions of emergency unemployment insurance and agricultural programs and yet another “doc fix” postponement of automatic cuts in Medicare payments to physicians. In addition, it delays until March a broad range of automatic federal spending cuts known as sequestration that otherwise would have begun this month.

Among the tax items not addressed by the act was the temporary lower 4.2% rate for employees’ portion of the Social Security payroll tax, which was not extended and has reverted to 6.2%.

Here are the act’s main tax features:

Individual tax rates

All the individual marginal tax rates under EGTRRA and JGTRRA are retained (10%, 15%, 25%, 28%, 33%, and 35%). A new top rate of 39.6% is imposed on taxable income over $400,000 for single filers, $425,000 for head-of-household filers, and $450,000 for married taxpayers filing jointly ($225,000 for each married spouse filing separately).

Phaseout of itemized deductions and personal exemptions

The personal exemptions and itemized deductions phaseout is reinstated at a higher threshold of $250,000 for single taxpayers, $275,000 for heads of household, and $300,000 for married taxpayers filing jointly.

Capital gains and dividends

A 20% rate applies to capital gains and dividends for individuals above the top income tax bracket threshold; the 15% rate is retained for taxpayers in the middle brackets. The zero rate is retained for taxpayers in the 10% and 15% brackets.

Alternative minimum tax

The exemption amount for the AMT on individuals is permanently indexed for inflation. For 2012, the exemption amounts are $78,750 for married taxpayers filing jointly and $50,600 for single filers. Relief from AMT for nonrefundable credits is retained.

Estate and gift tax

The estate and gift tax exclusion amount is retained at $5 million indexed for inflation ($5.12 million in 2012), but the top tax rate increases from 35% to 40% effective Jan. 1, 2013. The estate tax “portability” election, under which, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount, was made permanent by the act.

Permanent extensions

Various temporary tax provisions enacted as part of EGTRRA were made permanent. These include:

  • Marriage penalty relief (i.e., the increased size of the 15% rate bracket (Sec. 1(f)(8)) and increased standard deduction for married taxpayers filing jointly (Sec. 63(c)(2));
  • The liberalized child and dependent care credit rules (allowing the credit to be calculated based on up to $3,000 of expenses for one dependent or up to $6,000 for more than one) (Sec. 21);
  • The exclusion for National Health Services Corps and Armed Forces Health Professions Scholarships (Sec. 117(c)(2));
  • The exclusion for employer-provided educational assistance (Sec. 127);
  • The enhanced rules for student loan deductions introduced by EGTRRA (Sec. 221);
  • The higher contribution amount and other EGTRRA changes to Coverdell education savings accounts (Sec. 530);
  • The employer-provided child care credit (Sec. 45F);
  • Special treatment of tax-exempt bonds for education facilities (Sec 142(a)(13));
  • Repeal of the collapsible corporation rules (Sec. 341);
  • Special rates for accumulated earnings tax and personal holding company tax (Secs. 531 and 541); and
  • Modified tax treatment for electing Alaska Native Settlement Trusts (Sec. 646).

Individual credits expired at the end of 2012

The American opportunity tax credit for qualified tuition and other expenses of higher education was extended through 2018. Other credits and items from the American Recovery and Reinvestment Act of 2009, P.L. 111-5, that were extended for the same five-year period include enhanced provisions of the child tax credit under Sec. 24(d) and the earned income tax credit under Sec. 32(b). In addition, the bill permanently extends a rule excluding from taxable income refunds from certain federal and federally assisted programs (Sec. 6409).

Individual provisions expired at the end of 2011

The act also extended through 2013 a number of temporary individual tax provisions, most of which expired at the end of 2011:

  • Deduction for certain expenses of elementary and secondary school teachers (Sec. 62);
  • Exclusion from gross income of discharge of qualified principal residence indebtedness (Sec. 108);
  • Parity for exclusion from income for employer-provided mass transit and parking benefits (Sec. 132(f));
  • Mortgage insurance premiums treated as qualified residence interest (Sec. 163(h));
  • Deduction of state and local general sales taxes (Sec. 164(b));
  • Special rule for contributions of capital gain real property made for conservation purposes (Sec. 170(b));
  • Above-the-line deduction for qualified tuition and related expenses (Sec. 222); and
  • Tax-free distributions from individual retirement plans for charitable purposes (Sec. 408(d)).

Business tax extenders

The act also extended many business tax credits and other provisions. Notably, it extended through 2013 and modified the Sec. 41 credit for increasing research and development activities, which expired at the end of 2011. The credit is modified to allow partial inclusion in qualified research expenses and gross receipts those of an acquired trade or business or major portion of one. The increased expensing amounts under Sec. 179 are extended through 2013. The availability of an additional 50% first-year bonus depreciation (Sec. 168(k)) was also extended for one year by the act. It now generally applies to property placed in service before Jan. 1, 2014 (Jan. 1, 2015, for certain property with longer production periods).

Other business provisions extended through 2013, and in some cases modified, are:

  • Temporary minimum low-income tax credit rate for non-federally subsidized new buildings (Sec. 42);
  • Housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds (Section 3005 of the Housing Assistance Tax Act of 2008);
  • Indian employment tax credit (Sec. 45A);
  • New markets tax credit (Sec. 45D);
  • Railroad track maintenance credit (Sec. 45G);
  • Mine rescue team training credit (Sec. 45N);
  • Employer wage credit for employees who are active duty members of the uniformed services (Sec. 45P);
  • Work opportunity tax credit (Sec. 51);
  • Qualified zone academy bonds (Sec. 54E);
  • Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (Sec. 168(e));
  • Accelerated depreciation for business property on an Indian reservation (Sec. 168(j));
  • Enhanced charitable deduction for contributions of food inventory (Sec. 170(e));
  • Election to expense mine safety equipment (Sec. 179E);
  • Special expensing rules for certain film and television productions (Sec. 181);
  • Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (Sec. 199(d));
  • Modification of tax treatment of certain payments to controlling exempt organizations (Sec. 512(b));
  • Treatment of certain dividends of regulated investment companies (Sec. 871(k));
  • Regulated investment company qualified investment entity treatment under the Foreign Investment in Real Property Act (Sec. 897(h));
  • Extension of subpart F exception for active financing income (Sec. 953(e));
  • Lookthrough treatment of payments between related controlled foreign corporations under foreign personal holding company rules (Sec. 954);
  • Temporary exclusion of 100% of gain on certain small business stock (Sec. 1202);
  • Basis adjustment to stock of S corporations making charitable contributions of property (Sec. 1367);
  • Reduction in S corporation recognition period for built-in gains tax (Sec. 1374(d));
  • Empowerment Zone tax incentives (Sec. 1391);
  • Tax-exempt financing for New York Liberty Zone (Sec. 1400L);
  • Temporary increase in limit on cover-over of rum excise taxes to Puerto Rico and the Virgin Islands (Sec. 7652(f)); and
  • American Samoa economic development credit (Section 119 of the Tax Relief and Health Care Act of 2006, P.L. 109-432, as modified).

Energy tax extenders

The act also extends through 2013, and in some cases modifies, a number of energy credits and provisions that expired at the end of 2011:

  • Credit for energy-efficient existing homes (Sec. 25C);
  • Credit for alternative fuel vehicle refueling property (Sec. 30C);
  • Credit for two- or three-wheeled plug-in electric vehicles (Sec. 30D);
  • Cellulosic biofuel producer credit (Sec. 40(b), as modified);
  • Incentives for biodiesel and renewable diesel (Sec. 40A);
  • Production credit for Indian coal facilities placed in service before 2009 (Sec. 45(e)) (extended to an eight-year period);
  • Credits with respect to facilities producing energy from certain renewable resources (Sec. 45(d), as modified);
  • Credit for energy-efficient new homes (Sec. 45L);
  • Credit for energy-efficient appliances (Sec. 45M);
  • Special allowance for cellulosic biofuel plant property (Sec. 168(l), as modified);
  • Special rule for sales or dispositions to implement Federal Energy
  • Regulatory Commission or state electric restructuring policy for qualified electric utilities (Sec. 451); and
  • Alternative fuels excise tax credits (Sec. 6426).

Foreign provisions

The IRS’s authority under Sec. 1445(e)(1) to apply a withholding tax to gains on the disposition of U.S. real property interests by partnerships, trusts, or estates that are passed through to partners or beneficiaries that are foreign persons is made permanent, and the amount is increased to 20%.

New taxes

In addition to the various provisions discussed above, some new taxes also took effect Jan. 1 as a result of 2010’s health care reform legislation.

Additional hospital insurance tax on high-income taxpayers. The employee portion of the hospital insurance tax part of FICA, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer’s spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.

For self-employed taxpayers, the same additional hospital insurance tax applies to the hospital insurance portion of SECA tax on self-employment income in excess of the threshold amount.

Medicare tax on investment income. Starting Jan. 1, Sec. 1411 imposes a tax on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified adjusted gross income (AGI) exceeds a threshold amount. For estates and trusts, the tax equals 3.8% of the lesser of undistributed net investment income or AGI over the dollar amount at which the highest trust and estate tax bracket begins.

For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married taxpayers filing separately, it is $125,000; and for other individuals it is $200,000.

Net investment income means investment income reduced by deductions properly allocable to that income. Investment income includes income from interest, dividends, annuities, royalties, and rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business. However, income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is included in investment income.

Medical care itemized deduction threshold. The threshold for the itemized deduction for unreimbursed medical expenses has increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for all individuals, except, in the years 2013–2016, if either the taxpayer or the taxpayer’s spouse has turned 65 before the end of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI.

Flexible spending arrangement. Effective for cafeteria plan years beginning after Dec. 31, 2012, the maximum amount of salary reduction contributions that an employee may elect to have made to a flexible spending arrangement for any plan year is $2,500.

By Don James CPA/PFS, CFP

Increasing tax brackets may not result in increased taxes


Small businesses and tax increases

The President’s tax proposal to increase tax rates for families earning over $250,000 would seem to impact small business owners. Many of these businesses are formed as sole proprietorships and flow-through entities. The taxable income of these businesses flows through to the owners and is taxed on their personal returns. However, in most cases, the income actually remains in the business to finance growth.

Paying higher taxes will reduce the amount of profits business owners would otherwise re-invest in their companies, making them less likely to expand and hire more workers. Many economists agree that tax increases in general limit economic growth.

The President’s tax proposal would affect different types of small business owners differently. Many more small business owners who run partnerships and Sub Chapter S corporations will face higher taxes than small business owners who run sole proprietorships. That’s because S-Corps and partnerships tend to generate more income.  Of the 30.2 million pass through businesses that the Internal Revenue Service estimates are in operation in the United States, 77 percent are sole proprietorships. The effects on income are even more extreme because the income of S Corps and partnerships is more skewed than the income of sole proprietorships. An analysis by Ernst and Young shows that the tax increases will hit only 24 percent of sole proprietorship income, but 73 percent of S Corp income and 70 percent of partnership income.

How the AMT mitigates tax rate increases

However, a closer look at the president’s plan shows that a large majority of families making up to $300,000 — as well as hundreds of thousands of families with even larger incomes — would not pay taxes at a higher marginal rate. This is because the complexity of the tax code, such as the Alternative Minimum Tax (AMT), makes it difficult to draw clean lines.

After preparing several tax projections for clients assuming that their 2013 income will be the same as 2012, I am finding that many are in the 28% tax bracket for both years due to AMT. In other words, increasing taxpayers’ marginal rates will not result in a tax increase to the extent they are still in the AMT after calculating their regular tax using the increased rates. They are still in the 28% marginal tax bracket.

Note that yesterday the White House revised its plan to permanently extend Bush-era tax cuts on household incomes below $400,000, meaning that only the top tax bracket, 35 percent, would increase to 39.6 percent. The current cutoff between the top rate and the next highest rate, 33 percent, is $388,350. Still, most taxpayers with incomes over $400,000 are impacted by the AMT and may find that their tax increase is not as significant as they may have originally thought.

By Don James CPA/PFS, CFP

IRA and Retirement Plan Limits for 2013


IRA contribution limits

The maximum amount you can contribute to a traditional IRA or Roth IRA in 2013 increases to $5,500 (or 100% of your earned income, if less), up from $5,000 in 2012. The maximum catch-up contribution for those age 50 or older remains at $1,000. (You can contribute to both a traditional and Roth IRA in 2013, but your total contributions can’t exceed this annual limit.)

Traditional IRA deduction limits for 2013

The income limits for determining the deductibility of traditional IRA contributions have also increased for 2013 (for those covered by employer retirement plans). For example, you can fully deduct your IRA contribution if your filing status is single/head of household, and your income (“modified adjusted gross income,” or MAGI) is $59,000 or less (up from $58,000 in 2012). If you’re married and filing a joint return, you can fully deduct your IRA contribution if your MAGI is $95,000 or less (up from $92,000 in 2012). If you’re not covered by an employer plan but your spouse is, and you file a joint return, you can fully deduct your IRA contribution if your MAGI is $178,000 or less (up from $173,000 in 2012).

If your 2013 federal income tax filing status is:

Your IRA deduction is reduced if your MAGI is between:

Your deduction is eliminated if your MAGI is:

Single or head of household

$59,000 and $69,000

$69,000 or more

Married filing jointly or qualifying widow(er)*

$95,000 and $115,000 (combined)

$115,000 or more (combined)

Married filing separately

$0 and $10,000

$10,000 or more

*If you’re not covered by an employer plan but your spouse is, your deduction is limited if your MAGI is $178,000 to $188,000, and eliminated if your MAGI exceeds $188,000.

Roth IRA contribution limits for 2013

The income limits for determining how much you can contribute to a Roth IRA have also increased. If your filing status is single/head of household, you can contribute the full $5,500 to a Roth IRA in 2013 if your MAGI is $112,000 or less (up from $110,000 in 2012). And if you’re married and filing a joint return, you can make a full contribution if your MAGI is $178,000 or less (up from $173,000 in 2012). (Again, contributions can’t exceed 100% of your earned income.)

If your 2013 federal income tax filing status is:

Your Roth IRA contribution is reduced if your MAGI is:

You cannot contribute to a Roth IRA if your MAGI is:

Single or head of household

More than $112,000 but less than $127,000

$127,000 or more

Married filing jointly or qualifying widow(er)

More than $178,000 but less than $188,000 (combined)

$188,000 or more (combined)

Married filing separately

More than $0 but less than $10,000

$10,000 or more

Employer retirement plans

The maximum amount you can contribute (your “elective deferrals”) to a 401(k) plan has increased for 2013. The limit (which also applies to 403(b), 457(b), and SAR-SEP plans, as well as the Federal Thrift Plan) is $17,500 in 2013 (up from $17,000 in 2012). If you’re age 50 or older, you can also make catch-up contributions of up to $5,500 to these plans in 2013 (unchanged from 2012). (Special catch-up limits apply to certain participants in 403(b) and 457(b) plans.)

If you participate in more than one retirement plan, your total elective deferrals can’t exceed the annual limit ($17,500 in 2013 plus any applicable catch-up contribution). Deferrals to 401(k) plans, 403(b) plans, SIMPLE plans, and SAR-SEPs are included in this limit, but deferrals to Section 457(b) plans are not. For example, if you participate in both a 403(b) plan and a 457(b) plan, you can defer the full dollar limit to each plan–a total of $35,000 in 2013 (plus any catch-up contributions).

The amount you can contribute to a SIMPLE IRA or SIMPLE 401(k) plan has increased to $12,000 for 2013, up from $11,500 in 2012. The catch-up limit for those age 50 or older remains unchanged at $2,500.

Plan type:

Annual dollar limit:

Catch-up limit:

401(k), 403(b), governmental 457(b), SAR-SEP, Federal Thrift Plan

$17,500

$5,500

SIMPLE plans

$12,000

$2,500

Note: Contributions can’t exceed 100% of your income.

The maximum amount that can be allocated to your account in a defined contribution plan (for example, a 401(k) plan or profit-sharing plan) in 2013 is $51,000 (up from $50,000 in 2012), plus age-50 catch-up contributions. (This includes both your contributions and your employer’s contributions. Special rules apply if your employer sponsors more than one retirement plan.)

Finally, the maximum amount of compensation that can be taken into account in determining benefits for most plans has increased to $255,000, up from $250,000 in 2012; and the dollar threshold for determining highly compensated employees remains unchanged at $115,000.

By Don James CPA/PFS, CFP

 

Tax aspects of a parent entering a nursing home


I am frequently asked whether amounts paid for long-term medical care, including amounts paid to the nursing home, are deductible, whether insurance premiums covering the cost of long-term care including nursing home expenses (for the part of the year before your parent enters the nursing home) are deductible, and whether the gain on the sale of your parent’s home will qualify for the $250,000 exclusion. These matters and other tax aspects which you should consider in connection with your parent entering a nursing home are discussed below.

Deductibility of long-term medical care services.The costs of qualified long-term care, including nursing home care, are deductible as medical expenses to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income. 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 (eating, toileting, transferring, bathing, dressing, and continence) 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.). A person with Alzheimer’s disease qualifies.

Deductibility of premiums paid for qualified long-term care insurance.Premiums paid for a qualified long-term care insurance contract are deductible as medical expenses (subjects to an annual premium deduction limitation based on age, as explained below) to the extent they, along with other medical expenses, exceed 7.5% of adjusted gross income. A qualified long-term care insurance contract is insurance that covers only qualified long-term care services, doesn’t pay costs that are covered  by Medicare, is guaranteed renewable, and doesn’t have 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.

Qualified long-term care premiums are includible as medical expenses up to the following dollar amounts: For individuals over 60 to 70 years old, the 2012 limit on deductible long-term care insurance premiums is $3,500 ($3,390 for 2011), and for those over 70, $4,370 ($4,240 for 2011).

Deductibility of amounts paid to the nursing home.Amounts paid to a nursing home are fully deductible as a medical expense if the person is staying at the nursing home principally for medical, rather than custodial, etc., care.  If a person isn’t in the nursing home principally to receive medical care, then only the portion of the fee that is allocable to actual medical care qualifies as a deductible medical expense. But if the individual is chronically ill (as defined above), all  of the individual’s qualified long-term care services, including maintenance or personal care services, are deductible.

Including medical expenses you pay for your parent as part of your deductible medical expenses.If your parent qualifies as your dependent under the rules discussed below, you can include any medical expenses you incur for your parent along with your own when determining your medical deduction. If your parent doesn’t qualify as your dependent only because of the gross income or joint return test ((b) and (c), below), you can still include these medical costs with your own.

Claiming a parent confined to a nursing home as a dependent.You may be able to claim your parent as a dependent, thus qualifying for an exemption, even though your parent is confined to a nursing home. To qualify, (a) you must provide more than 50% of your parent’s support costs, (b) your parent must not have gross income in excess of the exemption amount ($3,800 in 2012; $3,700 in 2011), (c) your parent must not file a joint return for the year, and (d) your parent must be a U.S. citizen or a resident  of the U.S., Canada, or Mexico. Your parent can qualify as your dependent even though he or she doesn’t live with you, provided the support and other tests mentioned above are met.

Amounts you pay for qualified long-term  care services required  by your parent and eligible long-term care insurance premiums, discussed above, as well as amounts you pay to the nursing home for your parent’s medical care, are included in the total support you provide. If the support test ((a) above) can only be met by a group (you and your brothers and sisters, for example, combining to support your parent), a multiple support form can be filed to grant one of you the exemption, subject to certain conditions.

Qualification for head-of-household filing status. If you aren’t married and you are entitled to claim a dependency exemption for your parent, you may qualify for the head-of-household filing status, which is more favorable than the single filing status. You may be eligible to file as head of household even if the parent for whom you claim an exemption doesn’t live with you. In order to qualify for head-of-household status, generally you must have paid more than half the cost of maintaining a home for yourself and a qualifying relative for more than half the year. In the case of a parent, however, you may be eligible to file as head of household if you pay more than half the cost of maintaining a home that was the principal home for your parent for the entireyear. Thus, if your parent is confined to a nursing home, you are considered to be maintaining a principal home for your parent if you pay more than half the cost of keeping your parent in the nursing home.

Exclusion of gain on sale of your parent’s home.If your parent sells his or her home, up to $250,000 of the gain from the sale may be tax-free. In most cases, the seller, in order to qualify for this $250,000 exclusion,  must have (a) owned the home for at least two years out of the five years before the sale, and (b) used the home as his or her principal residence for at least two years out of the five years before the sale. However, there is an exception to the two-out-of-five-year  use test under (b) if the seller becomes physically or mentally unable to care for him or herself at any time during the five-year period.

Your parent can qualify for this exception to the use test if, during the five-year period before the sale, your parent (1) becomes physically or mentally unable to care for him or herself, and (2) your parent owned and lived in the home as his or her principal residence for a total of at least one year. Under this exception, your parent is treated as using the home as his or her principal residence during any time during the five-year period in which he or she owns the home and resides in any facility (including a nursing home) licensed by a state or political subdivision to care for an individual in your parent’s condition.

Exclusion for payments under life insurance contracts.If your parent is terminally or chronically ill and is insured under a life insurance contract, he or she may be able to receive tax-free payments (accelerated death benefits or so-called“viatical” payments) while living. 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. These lifetime payments could be used to help pay the costs of your parent’s nursing home.

Reverse mortgage as alternative to nursing home.It is often desirable for an elderly person to remain in his or her own home with proper in-home care rather than entering a nursing home. A reverse mortgage loan may make this a feasible alternative. Many states permit a reverse mortgage loan, which is designed to permit elderly persons with limited income to remain in their homes by borrowing against the value of their homes.

Typically, a bank commits itself to a principal amount based  on the appraised value of the property, which is loaned to the borrower in installments over a period of months or years. The monthly installments can be used to help pay for the upkeep of the home and for in-home care. Repayment of the loan is due when the  principal amount has been fully paid to the borrower, or the residence that secures the loan is sold, or the borrower dies or ceases to use the home as his principal residence.

The loan agreement may provide that interest will be added to the outstanding loan balance monthly as it accrues. However, the borrower can’t deduct this interest until it is actually paid.

By Don James, CPA/PFS, CFP

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APPLICATION OF THE 3.8% SURTAX TO INDIVIDUALS


For tax years beginning after 2012, new Internal Revenue Code (IRC) section 1411 imposes a 3.8 percent healthcare surtax on certain passive investment income of individuals and of trusts and estates based on a mathematical formula.

Contrary to numerous email posts circulating, it is not a sales tax on the sale of real estate.  See Example 6 below for how it could apply to the sale of a personal residence.

For individuals, the amount subject to the tax is the lesser of (1) net investment income (NII) or (2) the excess of a taxpayer’s modified adjusted gross income (MAGI) over an applicable threshold amount. Let’s first define each component of the formula.

Net Investment income. This is investment income reduced by any deductions properly allocable to such income. For purposes of the surtax, investment income includes:

  • Dividends
  • Rents
  • Interest
  • Capital gains
  • Annuities
  • Royalties
  • Passive activity income

There are also items of income that are specifically excluded. The surtax does not apply to:

  • Self-employment income
  • Non-resident aliens
  • Active Trade or business income
  • Gain on the sale of an active interest in partnership or S Corporation
  • IRA or qualified plan distributions
  • Trusts for charity (except Charitable Lead Trusts)

The active trade or business exclusion means that dividends, rents, interest, capital gains, annuities and royalties are not treated as NII to the extent they are derived from an active trade or business. Thus, if a taxpayer is not engaged in a passive activity business, NII includes only nonbusiness income from dividends, rents, interest, capital gains, annuities and royalties. No business income is included. If the taxpayer is engaged in a passive activity business, however, NII includes all the items listed above plus income from the passive activity.

Threshold Amounts. The applicable threshold amounts for individuals vary depending on filing status and are shown below.

Married taxpayers filing jointly………………$250,000

Married taxpayers filing separately…………$125,000

All other individual taxpayers………………..$200,000

Here are a few examples to help you better understand how 3.8% healthcare surtax on investment income will work.

Example 1. Jim, a single taxpayer has $110,000 of salary income and $60,000 of NII in 2013. The surtax applies to the lesser of $60,000 (NII) or the excess ofJim’s MAGI over the threshold amount of $200,000 for a single taxpayer. Because Jim’s income is less than $200,000, the excess amount is zero so no surtax is payable. Note that there can never be any surtax unless MAGI exceeds the applicable threshold amount.

Example 2. Herb and Cindy, married taxpayers filing jointly, have $1,000,000 of salary income and no NII. The surtax applies to the lesser of NII ($0) or the excess of $1,000,000 over the threshold amount of $250,000 for married taxpayers filing jointly ($750,000). Thus, no surtax is payable. There can be no surtax without NII regardless of how high MAGI is.

Example3. Bill and Gretchen, married taxpayers filing separately, have $300,000 of salaries and $100,000 of NII. The amount subject to the surtax is the lesser of NII ($100,000) or the excess of their MAGI over the threshold amount. The threshold amount is $250,000, so the excess amount is $150,000 ($400,000 -$250,000). Thus, the amount subject to the tax is $100,000 and the surtax payable is $3,800 (.038 x $100,000).

Example 4. Steve (age 71) and Beth (age 64), married taxpayers filing jointly, have NII of $125,000 and salary income of $125,000 in 2013. Steve receives a $60,000 RMD from his traditional IRA. The distribution is not NII, but it increases MAGI to $310,000. As a result, $60,000 of the NII is subject to the surtax because of the RMD.

Example 5. Assume the same facts as in Example 4 except that Steve converted his traditional IRA to a Roth IRA in 2011 and received a $60,000 distribution from the Roth IRA in 2013 rather than a $60,000 RMD from a traditional IRA. Unlike an RMD, a Roth distribution does not increase MAGI. As a result, MAGI stays at $250,000 and there is no surtax even though Steve and Beth have substantial NII.

Example 6. John and Mary sold their principal residence and realized a gain of $525,000.They have $325,000 Adjusted Gross Income (before adding taxable gain).

The tax applies as follows:

AGI Before Taxable Gain           $325,000

Gain on Sale of Residence         $525,000

Taxable Gain (Added to AGI)       $25,000  ($525,000 – $500,000*)

New AGI                                      $350,000  ($325,000 + $25,000 taxable gain)

Excess of AGI over $250,000     $100,000  ($350,000 – $250,000)

Lesser Amount (Taxable)               $25,000  (Taxable gain)

Tax Due                                               $950  ($25,000 x 0.038)

*Note that a married couple, filing a joint return, are only taxed on the gain of a personal residence to the extent it exceeds $500,000.

By Don James CPA/PFS, CFP

Changes to the Tax Code validated by Supreme Court’s decision on health care


In addition to making sweeping changes to the U.S. health care system, the health care reform legislation added a number of new taxes and made various other revenue-increasing changes to the Code to help finance health care reform. The legislation also made several health care–related changes to the Code to benefit certain taxpayers, including a credit to offset part of the costs of health insurance for low- to middle-income individuals and families and a credit to offset part of the costs to small businesses of providing health insurance for their employees.

Here is a list of tax-related items from the health care reform legislation—in addition to the Sec. 5000A individual health care mandate—that were upheld as a result of the Court’s decision:

Premium-assistance credit (Sec. 36B): Refundable tax credits that eligible taxpayers can use to help cover the cost of health insurance premiums for individuals and families who purchase health insurance through a state health benefit exchange. (Effective 2014.)

Small business tax credit (Sec. 45R): Small businesses—defined as businesses with 25 or fewer employees and average annual wages of $50,000 or less—would be eligible for a credit of up to 50% of nonelective contributions the business makes on behalf of their employees for insurance premiums. (Effective 2010.)

Tax-exempt health insurers: Program administered by the Department of Health and Human Services that will foster the creation of qualified nonprofit health insurance issuers to offer health insurance.

Reporting requirements (Sec. 6055): Requires insurers (including employers who self-insure) that provide minimum essential coverage to any individual during a calendar year to report certain health insurance coverage information to both the covered individual and to the IRS. (Effective 2014.)

Medical care itemized deduction threshold (Sec. 213): Threshold for the itemized deduction for unreimbursed medical expenses is increased from 7.5% of adjusted gross income (AGI) to 10% of AGI for regular income tax purposes. (Effective 2013 generally, 2017 for certain taxpayers.)

Cafeteria plans (Sec. 125): A qualified health plan offered through a health insurance exchange is a qualified benefit under a cafeteria plan of a qualified employer. (Effective 2014.)

Additional hospital insurance tax on high-income taxpayers (Sec. 3101): Employee portion of the Medicare hospital insurance tax part of FICA is increased by 0.9% on wages that exceed a threshold amount. (Effective 2013.)

Employer responsibility (Sec. 4980H): An “applicable large employer” that does not offer coverage for all its full-time employees, offers minimum essential coverage that is unaffordable, or offers minimum essential coverage that consists of a plan under which the plan’s share of the total allowed cost of benefits is less than 60%, is required to pay a penalty if any full-time employee is certified to the employer as having purchased health insurance through a state exchange with respect to which a tax credit or cost-sharing reduction is allowed or paid to the employee. (Effective 2014.)

Fees on health plans (Sec. 4375): Fee is imposed on each specified health insurance policy. (Effective Oct. 2012.)

Excise tax on high-cost employer plans (Sec. 4980I): Excise tax on coverage providers if the aggregate value of employer-sponsored health insurance coverage for an employee (including, for purposes of the provision, any former employee, surviving spouse, and any other primary insured individual) exceeds a threshold amount. (Effective 2018.)

Tax on health savings account (HSA) distributions (Sec. 223): Additional tax on distributions from an HSA or an Archer medical savings account (MSA) that are not used for qualified medical expenses is increased to 20% of the disbursed amount. (Effective 2011.)

Tax on indoor tanning services (Sec. 5000B): 10% tax on amounts paid for indoor tanning services. (Effective 2010.)

Health flexible spending arrangements (FSAs) (Sec. 125(i)): Maximum amount available for reimbursement of incurred medical expenses under a health FSA for a plan year (or other 12-month coverage period) must not exceed $2,500. (Effective 2013.)

SIMPLE cafeteria plans for small business (Sec. 125): An eligible small employer is provided with a safe harbor from the nondiscrimination requirements for cafeteria plans as well as from the nondiscrimination requirements for specified qualified benefits offered under a cafeteria plan. (Effective 2011.)

Expansion of adoption credit, adoption-assistance programs: Maximum adoption credit was increased and, for adoption-assistance programs, the maximum exclusion was increased. (Effective 2010; scheduled to expire at end of 2012.)

Charitable hospitals (Secs. 501(r) and 6033(b)(15)): New requirements applicable to Sec. 501(c)(3) hospitals, regarding conducting a community health needs assessment, adopting a written financial-assistance policy, limitations on charges, and collection activities. (Effective March 2010; community health needs assessment effective March 2012.)

Information reporting (Sec. 6051(a)(14)): Requires employers to disclose on each employee’s annual Form W-2 the value of the employee’s health insurance coverage sponsored by the employer. (Effective 2012.)

Return information disclosure (Sec. 6103): Allows the IRS, upon written request of the secretary of Health and Human Services, to disclose certain taxpayer return information if the taxpayer’s income is relevant in determining the amount of the tax credit or cost-sharing reduction, or eligibility for participation in the specified state health subsidy programs. (Effective March 2010.)

Medicare tax on investment income (Sec. 1411): Imposes a tax on individuals equal to 3.8% of the lesser of the individual’s net investment income for the year or the amount the individual’s modified AGI exceeds a threshold amount. (Effective 2013.)

Annual fee on pharmaceutical manufacturers and importers: Fee on each covered entity engaged in the business of manufacturing or importing branded prescription drugs for sale to any specified government program or pursuant to coverage under any such program. (Effective 2011.)

Excise tax on medical device manufacturers (Sec. 4191): Tax equal to 2.3% of the sale price is imposed on the sale of any taxable medical device by the manufacturer, producer, or importer of the device. (Effective 2013.)

Codification of the economic-substance doctrine (Sec. 7701(o)): Codifies the judicially created economic-substance doctrine and makes underpayments due to transactions that do not have economic substance subject to the Sec. 6662 accuracy-related penalty. (Effective 2010.)

Change to cellulosic biofuel producer credit (Sec. 40): Excludes from the definition of cellulosic biofuel any fuels that (1) are more than 4% (determined by weight) water and sediment in any combination or (2) have an ash content of more than 1% (determined by weight) (so-called black liquor). (Effective 2010.)

Deductions for federal subsidies for retiree prescription plans (Sec. 139A): Eliminates the rule that the exclusion for subsidy payments is not taken into account for purposes of determining whether a deduction is allowable for retiree prescription drug expenses. (Effective 2013.)

Adult dependent insurance coverage: Changes the definition of “dependent” for purposes of Sec. 105(b) (excluding from income amounts received under a health insurance plan) to include amounts expended for the medical care of any child of the taxpayer who has not yet reached age 27. The same change is made in Sec. 162(l)(1) for purposes of the self-employed health insurance deduction, in Sec. 501(c)(9) for purposes of benefits provided to members of a VEBA, and in Sec. 401(h) for benefits for retirees. (Effective 2010.)

Restrictions on use of HSA and FSA Funds (Sec. 223): Amounts paid for over-the-counter medications will no longer be reimbursable from HSAs, Archer MSAs, health FSAs, or health reimbursement arrangements. (Effective 2011.)

Time for payment of corporate estimated taxes for 2014: For corporations with assets of at least $1 billion (determined as of the end of the preceding tax year), estimated tax payments due in July, August, or September 2014 were increased.

Expanded 1099 reporting: This change was repealed by the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011, P.L. 112-9.

By Don James CPA/PFS, CFP

Planning for Potentially Higher Taxes on Investment Income


Through the end of this year, the so-called Bush tax cuts are locked in place. However, unless Congress takes action and the president approves (whoever he happens to be at the time), individual federal income tax rates will increase in 2013. Here is what is scheduled to happen to high-income individuals.

  • For 2013 and beyond, the top two rates on ordinary income, including net short-term capital gains, will increase to 36% and 39.6% (up from 33% and 35%, respectively).
  • For 2013 and beyond, high-income individuals may also be hit with an additional 0.9% Medicare tax on part of their wages and self-employment income. However, the additional 0.9% tax was part of the controversial 2010 Healthcare legislation, so it could be repealed or thrown out by the Supreme Court.
  • For 2013 and beyond, the maximum rate on most long-term capital gains will increase to 20% (up from 15%). However, an 18% maximum rate will apply to most long-term gains from selling assets that are: (1) acquired after 12/31/2000 and (2) held for more than five years.
  • For 2013 and beyond, dividends will be taxed at ordinary income rates, which could be as high as 39.6% (up from 15%).
  • For 2013 and beyond, high-income individuals may also be hit with an additional 3.8% Medicare contribution tax on all or part of their net investment income, which is defined to include long-term gains and dividends. However, the additional 3.8% tax was part of the controversial 2010 Healthcare legislation, so it could be repealed or thrown out by the Supreme Court.
  • For 2013 and beyond, the phase-out rules for personal and dependent exemption deductions and itemized deductions are scheduled to return with full force. These disguised tax increases will raise effective tax rates on investment income of higher-income individuals just that much higher.

Observation: It’s certainly possible that none of the aforementioned tax increases will actually come to pass. However the prudent thing to do is plan for the worst while hoping for the best. Planning for the worst is what we will do in this blog.

Details on Additional 3.8% Medicare Contribution Tax on Investment Income

For 2012, a 2.9% Medicare tax applies to salary and self-employment (SE) income. For an employee, 1.45% is withheld from his or her paychecks, and the other 1.45% is paid by the employer. A self-employed person pays the whole 2.9%. Investment income is not subject to the existing 2.9% Medicare tax.

Now for the bad news: starting in 2013 (which will be here before we know it), all or part of a high-income individual’s net investment income will get socked with an additional 3.8% “Medicare contribution tax” unless our Washington politicians take action.

Net Investment Income Defined. Net investment income for purposes of the additional 3.8% Medicare contribution tax is the sum of :

(1.) Net gain from property held for investment.

(2.) Gross income from dividends.

(3.) Gross income from interest.

(4.) Gross income from royalties.

(5.) Gross income from annuities.

(6.) Gross income from rents.

(7.) Gross income from passive business activities.

(8.) Gross income from the business of trading in financial instruments or commodities.

Minus deductions that are properly allocable to these income categories.

Exception for Business Activities: Income from categories 1-6 is generally not taken into account for purposes of the additional 3.8% Medicare contribution tax if the income is from a business activity.

Exception to the Exception: Income from categories 1-6 is taken into account if it is from a passive business activity or the business of trading in financial instruments or commodities. For example, net gains from selling passive rental properties could apparently be hit with the additional 3.8% Medicare contribution tax, and so could net gains from selling passive partnership interests and passive investments in S corporation stock.

Exception for Distributions from Tax-favored Retirement Plans: Net investment income for purposes of the additional 3.8% Medicare contribution tax does not include distributions from tax-favored retirement plans and accounts described in IRC Secs. 401(a) (qualified retirement plans), 403(a), 403(b), 408 (traditional IRAs), 408A (Roth IRAs), and 457(b).

Income Threshold and Tax Base. The additional 3.8% Medicare contribution tax will not apply unless Modified Adjusted Gross Income (MAGI) exceeds: (1) $200,000 for an unmarried individual, (2) $250,000 for a married joint-filing couple, or (3) $125,000 for those who use married filing separate status. These MAGI thresholds are not adjusted for inflation. MAGI means regular AGI plus the excess of the amount excluded from gross income under the IRC Sec. 911(a)(1) foreign earned income exclusion over any deductions or exclusions that are disallowed under IRC Sec. 911(b)(6) with respect to such excluded foreign earned income.

The additional 3.8% Medicare contribution tax will only apply to the lesser of: (1) net investment income or (2) the amount of MAGI in excess of the applicable threshold.

Example 1: Barry and Sherry, a married joint-filing couple, have 2013 MAGI of $265,000 and $60,000 of net investment income. They will owe the 3.8% additional Medicare contribution tax on $15,000 ($265,000 MAGI less the $250,000 threshold). The $570 ($15,000 x 3.8%) Medicare contribution tax should be included in their 2013 estimated tax payments.

Example 2: Harry and Teri, a married joint-filing couple, have 2013 MAGI of $350,000 and $60,000 of net investment income. They will owe the 3.8% Medicare contribution tax on $60,000 (the entire amount of their net investment income). This $2,280 ($60,000 x 3.8%) tax should be included in their 2013 estimated tax payments.

Example 3: Fritz, an unmarried individual, has 2013 MAGI of $180,000 and $100,000 of net investment income. He will not owe the 3.8% Medicare because his MAGI is below the $200,000 threshold for unmarried taxpayers.

Trust Income Can Also Be Affected. For a trust, the additional 3.8% Medicare contribution tax will apply to the lesser of: (1) undistributed net investment income or (2) the amount of AGI in excess of the threshold for the top trust federal income tax bracket. (For 2012, that threshold is a mere $11,650.)

Tax Rate Impact. Thanks to the additional 3.8% Medicare contribution tax in conjunction with other scheduled rate increases, the following maximum federal rates will apply in 2013 unless something changes:

  • 23.8% (20% + 3.8%) on net long-term gains in excess of net short-term capital losses (versus 15% for 2012).
  • 23.8% (20% + 3.8%) on net Section 1231 gains from passive business activities (versus 15% for 2012).
  • 43.4% (39.6% + 3.8%) on net short-term gains in excess of net long-term capital losses (versus 35% for 2012).
  • 43.4% (39.6% + 3.8%) on net dividend income (versus 15% for 2012).
  • 43.4% (39.6% + 3.8%) on net interest, royalty, annuity, and rental income (versus 35% for 2012).
  • 43.4% (39.6% + 3.8%) on net ordinary income from passive business activities and net ordinary income from the business of trading in financial instruments or commodities (versus 35% for 2012).

Planning to Mitigate Higher Taxes on Investment Income

Investment gains that would be subject to higher tax rates if they are recognized in 2013 won’t be hit with those higher rates if the gains are recognized this year. Therefore, investors should consider triggering gains by unloading affected appreciated assets by 12/31/12 instead of hanging onto them. That said, the tax tail should not wag the investment dog. Investors should only unload assets that they are thinking about unloading anyway. After the recent stock market run-up, it should not be too hard to find some.

On the other hand, holding onto depreciated investment assets (say rental real estate properties that were acquired at the top of the market) until after this year could be beneficial because losses from unloading them in 2013 and beyond could shelter investors from higher future tax rates on net investment income. Losses would reduce: (1) taxable income for regular tax rate purposes, (2) AGI for purposes of various phase-out rules, and (3) MAGI and net investment income for purposes of the additional 3.8% Medicare contribution tax.

Don’t Forget about the Other New Medicare Tax Scheduled to Take Effect Next Year

We have more bad news, although this item doesn’t affect investment income. Starting with tax years beginning in 2013, an extra 0.9% Medicare tax will be charged on: (1) salary and/or SE income above $200,000 for an unmarried individual, (2) combined salary and/or SE income above $250,000 for a married joint-filing couple, and (3) salary and/or SE income above $125,000 for those who use married filing separate status. These thresholds are not adjusted for inflation.

For self-employed individuals, the additional 0.9% Medicare tax hit will come in the form of a higher SE bill. However, the additional 0.9% Medicare tax will not qualify for the above-the-line deduction for 50% of SE tax. The additional 0.9% Medicare tax must be taken into account for estimated tax payment purposes.

IRS issues new “repair regulations” – Here is what you need to know


The IRS has released much-anticipated temporary and proposed regulations on the capitalization of costs incurred for tangible property. They impact how virtually any business writes off costs that repair, maintain, improve or replace any tangible property used in the business, from office furniture to roof repairs to photocopy maintenance and everything in between. They apply immediately, to tax years beginning on or after January 1, 2012.

These so-called “repair regulations” are broad and comprehensive. They apply not only to repairs, but to the capitalization of amounts paid to acquire, produce or improve tangible property. They are intended to clarify and expand existing regulations, set out some bright-line tests, and provide some safe harbors for deducting payments.

The regulations are an ambitious effort to address capitalization of specific expenses associated with tangible property. The regulations affect manufacturers, wholesalers, distributors, and retailers—everyone who uses tangible property, whether the property is owned or leased. The rules provide a more defined framework for determining capital expenditures.

Most taxpayers will have to make changes to their method of accounting to comply with the temporary regulations and will need to file Form 3115. Taxpayers who filed for a change of accounting method following the issuance of the 2008 proposed regulations will probably have to change their accounting method again.

The IRS has promised to issue two revenue procedures that will provide transition rules for taxpayers changing their method of accounting, including the granting of automatic consent to make the change. The regulations require taxpayers to make a Code Sec. 481(a) adjustment; this means that taxpayers will have to apply the regulations to costs incurred both prior to and after the effective date of the regulations.

The new regulations provide rules for materials and supplies that can be deducted, rather than capitalized. The rules provide several methods of accounting for rotable and temporary spare parts, and allow taxpayers to apply a de minimis rule so that they can deduct materials and supplies when they are purchased, not when they are consumed.

Costs to acquire, produce or improve tangible property must be capitalized. The regulations address moving and reinstallation costs, work performed prior to placing property into service, and transaction costs. Generally, costs of simply removing property can be deducted, but costs of moving and then reinstalling property may have to be capitalized.

To determine whether a cost incurred for property is an improvement, it is necessary to determine the unit of property. Generally, the larger the unit of property, the easier it is to deduct expenses, rather than have to capitalize them. The regulations provide detailed rules for determining the unit of property for buildings and for non-building tangible property. For buildings, the IRS identified eight component systems as separate units of property, requiring more costs to be capitalized. However, the new rules also provide for deducting the costs of property taken out of service, by treating the retirement as a disposition.

The new regulations require virtually every business to review how repairs, maintenance, improvements and replacements are handled for tax purposes, with both mandatory and optional adjustments made to past treatment as appropriate.

By Don James CPA/PFS, CFP

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

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.

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%

 

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.

 

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.

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.

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 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.

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.

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.

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.

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.

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

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.

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.

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.

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 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.

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.

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:

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.

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.

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.

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.

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.

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’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.

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.

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