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The IRS has provided details clarifying the federal tax status involving special payments made by 21 states in 2022. Taxpayers in many states will not need to report these payments on their 2022 tax returns.

The IRS has provided details clarifying the federal tax status involving special payments made by 21 states in 2022. Taxpayers in many states will not need to report these payments on their 2022 tax returns.

General welfare and disaster relief payments

If a payment is made for the promotion of the general welfare or as a disaster relief payment, for example related to the COVID 19 pandemic, it may be excludable from income for federal tax purposes under the General Welfare Doctrine or as a Qualified Disaster Relief Payment. Payments from the following states fall in this category and the IRS will not challenge the treatment of these payments as excludable for federal income tax purposes in 2022:

• California,

• Colorado,

• Connecticut,

• Delaware,

• Florida,

• Hawaii,

• Idaho,

• Illinois,

• Indiana,

• Maine,

• New Jersey,

• New Mexico,

• New York,

• Oregon,

• Pennsylvania, and

• Rhode Island.

Alaska is in this group only for the supplemental Energy Relief Payment received in addition to the annual Permanent Fund Dividend. Illinois and New York issued multiple payments and in each case one of the payments was a refund of taxes to which the above treatment applies, and one of the payments is in the category of disaster relief payment. A list of payments to which the above treatment applies is available on the IRS website.

Refund of state taxes paid

If the payment is a refund of state taxes paid and recipients either claimed the standard deduction or itemized their deductions but did not receive a tax benefit (for example, because the $10,000 tax deduction limit applied) the payment is not included in income for federal tax purposes. Payments from the following states in 2022 fall in this category and will be excluded from income for federal tax purposes unless the recipient received a tax benefit in the year the taxes were deducted.

• Georgia,

• Massachusetts,

• South Carolina, and

• Virginia

Other Payments

Other payments that may have been made by states are generally includable in income for federal income tax purposes. This includes the annual payment of Alaska’s Permanent Fund Dividend and any payments from states provided as compensation to workers.

The IRS intends to change how it defines vans, sports utility vehicles (SUVs), pickup trucks and “other vehicles” for purposes of the Code Sec. 30D new clean vehicle credit. These changes are reflected in updated IRS Frequently Asked Questions (FAQs) for the new, previously owned and commercial clean vehicle credits.

The IRS intends to change how it defines vans, sports utility vehicles (SUVs), pickup trucks and “other vehicles” for purposes of the Code Sec. 30D new clean vehicle credit. These changes are reflected in updated IRS Frequently Asked Questions (FAQs) for the new, previously owned and commercial clean vehicle credits.

Clean Vehicle Classification Changes

For a vehicle to qualify for the new clean vehicle credit, its manufacturer’s suggested retail price (MSRP) cannot exceed:

• $80,000 for a van, SUV or pickup truck; or

• $55,000 for any other vehicle.

In December, the IRS announced that proposed regulations would define these vehicle types by reference to the general definitions provided in Environmental Protection Agency (EPA) regulations in 40 CFR 600.002 (Notice 2023-1).

However, the IRS has now determined that these vehicles should be defined by reference to the fuel economy labeling rules in 40 CFR 600.315-08. This change means that some vehicles that were formerly classified as “other vehicles” subject to the $55,000 price cap are now classified as SUVs subject to the $80,000 price cap.

Until the IRS releases proposed regulations for the new clean vehicle credit, taxpayers may rely on the definitions provided in Notice 2023-1, as modified by today’s guidance. These modified definitions are reflected in the Clean Vehicle Qualified Manufacturer Requirements page on the IRS website, which lists makes and models that may be eligible for the clean vehicle credits.

Expected Definitions of Vans, SUVs, Pickup Trucks and Other Vehicles

The EPA fuel economy standards establish a large category of nonpassenger vehicles called “light trucks.” Within this category, vehicles are defined largely by their gross vehicle weight ratings (GVWR) as follows:

• Vans, including minivans

• Pickup trucks, including small pickups with a GVWR below 6,000 pounds, and standard pickups with a GVWR between 6,000 and 8,500 pounds

• SUVs, including small SUVs with a GVWR below 6.000 pounds, and standard SUVs with a GVWR between 6,000 and 10,000 pounds

• Other vehicles (passenger automobiles) that, based on seating capacity of interior volume, are classified as two-seaters; mini-compact, subcompact, compact, midsize, or large cars; and small, midsize, or large station wagons.

However, the EPA may determine that a particular vehicle is more appropriately placed in a different category. In particular, the EPA may determine that automobiles with GVWR of up to 8,500 pounds and medium-duty passenger vehicles that possess special features are more appropriately classified as “special purpose vehicles.” These special features may include advanced technologies, such as battery electric vehicles, fuel cell vehicles, plug-in hybrid electric vehicles and vehicles equipped with hydrogen internal combustion engines.

FAQ Updates

The IRS also updated its frequently asked questions (FAQs) page for the Code Sec. 30D new clean vehicle credit, the Code Sec. 25E previously owned vehicle credit and the Code Sec. 45W qualified commercial clean vehicles credit. In addition to incorporating the new definitions discussed above, these updates:

• Define “original use” and "MSRP;"

• Describe the information a seller must provide to the taxpayer and the IRS;

• Clarify that the MSRP caps apply to a vehicle placed in service (delivered to the taxpayer) in 2023, even if the taxpayer purchased it in 2022; and

• Explain what constitutes a lease.

Effect on Other Documents

Notice 2023-1 is modified. Taxpayers may rely on the definitions provided in Notice 2023-1, as modified by Notice 2023-16, until the IRS releases proposed regulations for the new clean vehicle credit.

The IRS established the program to allocate environmental justice solar and wind capacity limitation (Capacity Limitation) to qualified solar and wind facilities eligible for the Low-Income Communities Bonus Credit Program component of the energy investment credit.

The IRS established the program to allocate environmental justice solar and wind capacity limitation (Capacity Limitation) to qualified solar and wind facilities eligible for the Low-Income Communities Bonus Credit Program component of the energy investment credit. The IRS also provided:

• initial guidance regarding the overall program design ,

• the application process, and

• additional criteria that will be considered in making the allocations.

After the 2023 allocation process begins, the Treasury Department and IRS will monitor and assess whether to implement any modifications to the Low-Income Communities Bonus Credit Program for calendar year 2024 allocations of Capacity Limitation.

Facility Categories, Capacity Limits, and Application Dates

The program establishes four facilities categories and the capacity limitation for each:

The IRS anticipates applications will be accepted for Category 3 and Category 4 facilities in the third quarter of 2023. Applications for Category 1 and Category 2 facilities will be accepted thereafter. The IRS will issue additional guidance regarding the application process and facility eligibility.

The program will also incorporate additional criteria in determining how to allocate the Capacity Limitation reserved for each facility category among eligible applicants. These may include a focus on facilities that are owned or developed by community-based organizations and mission-driven entities, have an impact on encouraging new market participants, provide substantial benefits to low-income communities and individuals marginalized from economic opportunities, and have a higher degree of commercial readiness.

Finally, only the owner of a facility may apply for an allocation of Capacity Limitation. Facilities placed in service prior to being awarded an allocation of Capacity Limitation are not eligible to receive an allocation. The Department of Energy (DOE) will provide administration services for the Low-Income Communities Bonus Credit Program. An allocation of an amount of capacity limitation is not a determination that the facility will qualify for the energy investment credit or the increase in the credit under the Low-Income Communities Bonus Credit Program.

The IRS announced a program to allocate $10 billion of credits for qualified investments in eligible qualifying advanced energy projects (the Code Sec. 48C(e) program). At least $4 billion of these credits may be allocated only to projects located in certain energy communities.

The IRS announced a program to allocate $10 billion of credits for qualified investments in eligible qualifying advanced energy projects (the Code Sec. 48C(e) program). At least $4 billion of these credits may be allocated only to projects located in certain energy communities.

The guidance announcing the program also:

• defines key terms, including qualifying advanced energy project, specified advanced energy property, eligible property, the placed in service date, industrial facility, manufacturing facilities, and recycling facility;

• describes the prevailing wage and apprenticeship requirements, along with remediation options; and

• sets forth the program timeline and the steps the taxpayer must follow.

Application and Certification Process

For Round 1 of the Section 48C(e) program, the application period begins on May 31, 2023. The IRS expects to allocate $4 billion in credit in this round, including $1.6 billion to projects in energy communities.

The taxpayer must submit a concept paper detailing the project by July 31, 2023. The taxpayer must also certify under penalties of perjury that it did not claim a credit under several other Code Sections for the same investment.

Within two years after the IRS accepts an allocation application, the taxpayer must submit evidence to the DOE to establish that it has met all requirements necessary to commence construction of the project. DOE then notifies the IRS, and the IRS certifies the project.

Taxpayers generally submit their papers through the Department of Energy (DOE) eXHANGE portal at https://infrastructure-exchange.energy.gov/. The DOE must recommend and rank the project to the IRS, and have a reasonable expectation of its commercial viability.

Energy Communities and Progress Expenditures

The guidance also provides additional procedures for energy communities and the credit for progress expenditures.

For purposes of the minimum $4 billion allocation for projects in energy communities, the DOE will determine which projects are in energy community census tracts. Additional guidance is expected to provide a mapping tool that applicants for allocations may use to determine if their projects are in energy communities.

Finally, the guidance explains how taxpayers may elect to claim the credit for progress expenditures paid or incurred during the tax year for construction of a qualifying advanced energy project. The taxpayer cannot make the election before receiving its certification letter.

The IRS has released new rules and conditions for implementing the real estate developer alternative cost method. This is an optional safe harbor method of accounting for real estate developers to determine when common improvement costs may be included in the basis of individual units of real property in a real property development project held for sale to determine the gain or loss from sales of those units.

The IRS has released new rules and conditions for implementing the real estate developer alternative cost method. This is an optional safe harbor method of accounting for real estate developers to determine when common improvement costs may be included in the basis of individual units of real property in a real property development project held for sale to determine the gain or loss from sales of those units.

Background

Under Code Sec. 461, developers cannot add common improvement costs to the basis of benefitted units until the costs are incurred under the Code Sec. 461(h) economic performance requirements. Thus, common improvement costs that have not been incurred under Code Sec. 461(h) when the units are sold cannot be included in the units' basis in determining the gain or loss resulting from the sales. Rev. Proc. 92-29, provided procedures under which the IRS would consent to developers including the estimated cost of common improvements in the basis of units sold without meeting the economic performance requirements of Code Sec. 461(h). In order to use the alternative cost method, the taxpayer had to meet certain conditions, provide an estimated completion date, and file an annual statement.

Rev. Proc. 2023-9 Alterative Cost Method

In releasing Rev. Proc. 2023-9, the IRS and Treasury stated that they recognized certain aspects of Rev. Proc. 92-29 are outdated, place additional administrative burdens on developers and the IRS, and that application of the method to contracts accounted for under the long-term contract method of Code Sec. 460 may be unclear.

The alternative cost method must be applied to all projects in a trade or business that meet the definition of a qualifying project. However, the alternative cost limitation of this revenue procedure is calculated on a project-by-project basis. Thus, common improvement costs incurred for one qualifying project may not be included in the alternative cost method calculations of a separate qualifying project.

The revenue procedure provides definitions including definitions of "qualifying project,""reasonable method," and "CCM contract" (related to the completed contract method). It provides rules for application of the alternative cost method for developers using the accrual method of accounting and the completed contract method of accounting, rules for allocating estimated common improvement costs, and a method for determining the alternative costs limitation. The revenue procedure also provides examples of how its rules are applied.

Accounting Method Change Required

Under Rev. Proc. 2023-9, the alternative cost method is a method of accounting. A change to this alternative cost method is a change in method of accounting to which Code Secs. 446(e) and 481 apply. An eligible taxpayer that wants to change to the Rev. Proc. 2023-9 alternative cost method or that wants to change from the Rev. Proc. 92-29 alternative cost method, must use the automatic change procedures in Rev. Proc. 2015-13 or its successor. In certain cases, taxpayers may use short Form 3115 in lieu of the standard Form 3115 to make the change.

Effective Date

This revenue procedure is effective for tax years beginning after December 31, 2022.

The IRS announced that taxpayers electronically filing their Form 1040-X, Amended U.S Individual Income Tax Return, will for the first time be able to select direct deposit for any resulting refund. 

The IRS announced that taxpayers electronically filing their Form 1040-X, Amended U.S Individual Income Tax Return, will for the first time be able to select direct deposit for any resulting refund. Previously, taxpayers had to wait for a paper check for any refund, a step that added time onto the amended return process. Following IRS system updates, taxpayers filing amended returns can now enjoy the same speed and security of direct deposit as those filing an original Form 1040 tax return. Taxpayers filing an original tax return using tax preparation software can file an electronic Form 1040-X if the software manufacturer offers that service. This is the latest step the IRS is taking to improve service this tax filing season.

Further, as part of funding for the Inflation Reduction Act, the IRS has hired over 5,000 new telephone assistors and is adding staff to IRS Taxpayer Assistance Centers (TACs). The IRS also plans special service hours at dozens of TACs across the country on four Saturdays between February and May. No matter how a taxpayer files the amended return, they can still use the "Where's My Amended Return?" online tool to check the status. Taxpayers still have the option to submit a paper version of Form 1040-X and receive a paper check. Direct deposit is not available on amended returns submitted on paper. Current processing time is more than 20 weeks for both paper and electronically filed amended returns.

"This is a big win for taxpayers and another achievement as we transform the IRS to improve taxpayer experiences," said IRS Acting Commissioner Doug O’Donnell. "This important update will cut refund time and reduce inconvenience for people who file amended returns. We always encourage directdeposit whenever possible. Getting tax refunds into taxpayers’ hands quickly without worry of a lost or stolen paper check just makes sense."

The OECD/G20 Inclusive Framework released a package of technical and administrative guidance that achieves clarity on the global minimum tax on multinational corporations known as Pillar Two. Further, it provides critical protections for important tax incentives, including green tax credit incentives established in the Inflation Reduction Act. 

The OECD/G20 Inclusive Framework released a package of technical and administrative guidance that achieves clarity on the global minimum tax on multinational corporations known as Pillar Two. Further, it provides critical protections for important tax incentives, including green tax credit incentives established in the Inflation Reduction Act. Pillar Two provides for a global minimum tax on the earnings of large multinational businesses, leveling the playing field for U.S. businesses and ending the race to the bottom in corporate income tax rates. This package follows the release of the Model Rules in December 2021, Commentary in March 2022 and rules for a transitional safe harbor in December 2022. The guidance will be incorporated into a revised version of the Commentary that will replace the prior version.

Additionally, the package includes guidance on over two dozen topics, addressing those issues that Inclusive Framework members identified are most pressing. This includes topics relating to the scope of companies that will be subject to the Global Anti-Base Erosion (GloBE) Rules and transition rules that will apply in the initial years that the global minimum tax applies. Additionally, it includes guidance on Qualified Domestic Minimum Top-up Taxes (QDMTTs) that countries may choose to adopt.

"The continued progress in implementing the globalminimum tax represents another step in leveling the playing field for U.S. businesses, while also protecting U.S. workers and middle-class families by ending the race to the bottom in corporate tax rates," said Assistant Secretary of the Treasury for Tax Policy Lily Batchelder. "We welcome this agreed guidance on key technical questions, which will deliver certainty for green energy tax incentives, support coordinated outcomes and provide additional clarity that stakeholders have asked for."

The health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010) imposes a new 3.8 percent Medicare contribution tax on the investment income of higher-income individuals. Although the tax does not take effect until 2013, it is not too soon to examine methods to lessen the impact of the tax.

Net investment income

"Net investment income" includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property not used in an active business and income from the investment of working capital are also treated as investment income. Further, an individual's capital gains income will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Sec. 121, and gains from the sale of a vacation home. However, contemplated sales made before 2013 would avoid the tax.

The tax applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute.

However, the tax will not apply to nontaxable income, such as tax-exempt interest or veterans' benefits.

Deductions

Net investment income is gross income or net gain, reduced by deductions that are "properly allocable" to the income or gain. This is a key term that the Treasury Department expects to address in guidance, and which we will update on developments. For passively-managed real property, allocable expenses will still include depreciation and operating expenses. Indirect expenses such as tax preparation fees may also qualify.

For capital gain property, this formula puts a premium on keeping tabs on amounts that increase your property's basis. It also focuses on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers' fees, may increase basis or reduce the amount realized from an investment. As such, taxpayers may want to consider avoiding installment sales with net capital gains (and interest) running past 2012.

Thresholds

The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately. MAGI is your AGI increased by any foreign earned income otherwise excluded under Code Sec. 911; MAGI is the same as AGI for someone who does not work overseas.

Example. Jim, a single individual, has modified AGI of $220,000 and net investment income of $40,000. The tax applies to the lesser of (i) net investment income ($40,000) or (ii) modified AGI ($220,000) over the threshold amount for an individual ($200,000), or $20,000. The tax is 3.8 percent of $20,000, or $760. In this case, the tax is not applied to the entire $40,000 of investment income.

Exceptions to the tax

Certain items and taxpayers are not subject to the 3.8 percent Medicare tax. A significant exception applies to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans. There is no exception for distributions from nonqualified deferred compensation plans subject to Code Sec. 409A. However, distributions from these plans (including amounts deemed as interest) are generally treated as compensation, not as investment income.

The exception for distributions from retirement plans suggests that potentially taxable investors may want to shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities, and IRAs, or to 409A deferred compensation plans. Increasing contributions will reduce income and may help you stay below the applicable thresholds. Small business owners may want to set up retirement plans, especially 401(k) plans, if they have not yet established a plan, and should consider increasing their contributions to existing plans.

Another exception is provided for income ordinarily derived from a trade or business that is not a passive activity under Code Sec. 469, such as a sole proprietorship. Investment income from an active trade or business is also excluded. However, SECA (Self-Employment Contributions Act) tax will still apply to proprietors and partners. Income from trading in financial instruments and commodities is also subject to the tax.

The additional 3.8 percent Medicare tax does not apply to income from the sale of an interest in a partnership or S corporation, to the extent that gain of the entity's property would be from an active trade or business. The tax also does not apply to business entities (such as corporations and limited liability companies), nonresident aliens (NRAs), charitable trusts that are tax-exempt, and charitable remainder trusts that are nontaxable under Code Sec. 664.

Income tax rates

In addition to the tax on investment income, certain other tax increases proposed by the Obama administration may take effect in 2011. The top two marginal income tax rates on individuals would rise from 33 and 35 percent to 36 and 39.6 percent, respectively. The maximum tax rate on long-term capital gains would increase from 15 percent to 20 percent. Moreover, dividends, which are currently capped at the 15 percent long-term capital gain rate, would be taxed as ordinary income. Thus, the cumulative rate on capital gains would increase to 23.8 percent in 2013, and the rate on dividends would jump to as much as 43.4 percent. Moreover, the thresholds are not indexed for inflation, so more taxpayers may be affected as time elapses.

Please contact our office if you would like to discuss the tax consequences to your investments of the new 3.8 percent Medicare tax on investment income.

The answer is no for 2010, but yes, in practical terms, for 2014 and beyond. The health care reform package (the Patient Protection and Affordable Care Act of 2010 and the Health Care and Education Reconciliation Act of 2010) does not require individuals to carry health insurance in 2010. However, after 2013, individuals without minimum essential health insurance coverage will be liable for a penalty unless otherwise exempt.

Shared responsibility

The health care reform package describes health insurance coverage as "shared responsibility." Individuals, employers, the federal government, and the states all have roles to play in guaranteeing that individuals do not lack minimum essential health insurance coverage.

The health care reform package assumes that employer-provided health insurance will continue to be the primary means of delivering coverage after 2013. The health care reform package includes measures that lawmakers hope will keep premium costs down along with tax incentives, so employers continue to offer health insurance. For larger employers (those with 50 or more employees), that "encouragement" is also combined with penalties if alternate health insurance is not offered.

Millions of Americans are also currently covered by Medicaid, Medicare and other government programs. They will continue to be covered by these programs after 2013. Indeed, some of these government programs will be expanded between now and 2013, covering more individuals.

Individual responsibility

Beginning in 2014, the health care reform package imposes a penalty on individuals for each month they fail to have minimum essential health insurance coverage for themselves and their dependents. Another name for the penalty is "shared responsibility payment."

As a baseline, all individuals without minimum essential health insurance coverage will be liable for the penalty. However, the health care reform package expressly excludes certain individuals from liability for the penalty. They include:

• Individuals whose household income is below their income thresholds for filing a federal income tax return;
  
• Individuals who are exempt on religious conscience grounds;
  
• Individuals whose contribution to employer-provided coverage exceeds a threshold percentage;
  
• Hardship cases;
  
• Native Americans;
  
• Undocumented aliens;
  
• Incarcerated individuals;
  
• Individuals with short lapses of minimum essential coverage;
  
• Individuals covered by Medicare, Medicaid and other government programs; and
  
• Certain individuals outside the U.S.

Amount of penalty

The monthly penalty after 2013 is 1/12 of the flat dollar amount or a percentage of income, whichever is greater. For 2014, the flat dollar amount is $95 and the percentage of income is one percent. The flat dollar amount rises to $695 in 2016 (indexed for inflation thereafter) and the percentage of income increases to 2.5 percent.

For individuals under age 18, the flat dollar amount is 50 percent of the amount for adults. Generally, a family's total penalty cannot exceed $285 for 2014 (rising to $2,085 by 2016) or the national average annual premium for the "bronze" level of coverage through a state insurance exchange. By 2014, each state must establish an insurance exchange where individuals can shop for health insurance coverage. The exchanges will have four levels of coverage: bronze, silver, gold, and platinum.

Example. Ana, age 38, is self-employed with a modified adjusted gross income (AGI) of $68,500 for 2014. Ana does not have minimum essential coverage for all 12 months of 2014 and is not exempt from carrying minimum essential coverage because of income or other qualifying reasons. Ana will be liable for a penalty of the greater of $95 or one percent of her modified AGI.

Example. Ana's mother, Barbara, is enrolled in Medicare. Barbara has minimum essential coverage because she is enrolled in Medicare and is not liable for a penalty.

Health insurance tax credits

At the same time the individual responsibility requirement kicks in, the health care reform package provides a refundable health insurance premium assistance tax credit to qualified persons. The premium assistance credit will operate on a sliding scale based on an individual's relationship to the federal poverty level (between 100 and 400 percent).

The healthcare reform package makes the premium assistance tax credit refundable and also provides for advance payment of the credit. Advance payment will be made to the health plan in which the individual is enrolled.

Adult children

There is one important change regarding individual coverage for 2010. Effective September 23, 2010, the health care reform package enables more young adults to remain on their parents' health insurance policies. Generally, employer-sponsored group health plans will be required to provide coverage for adult children up to age 26 if the adult child is ineligible to enroll in another employer-sponsored plan. The health care reform package also extends the employer-provided health coverage gross income exclusion to coverage for adult children under age 27 as of the end of the tax year.

Guidance

The IRS, the U.S. Department of Health and Human Services and other federal agencies are expected to issue extensive guidance on the individual responsibility mandate. Our office will keep you posted on developments.

Health care reform is now law and many employers are asking how does it affect my business and my employees? The first thing to keep in mind is that reform is gradual. The health care reforms and tax provisions in the new health care reform package play out over time, with some taking effect this year or next year but others not until 2014 and beyond. However, the health care package imposes significant new responsibilities and taxes on employers and individuals so it is not too early to start preparing.

Two new laws

Health care reform is actually made up of two new laws. The first is the Patient Protection and Affordable Care Act of 2010, signed by President Obama on March 23. The second is the Health Care and Education Reconciliation Act of 2010, signed by the president on March 26. The Patient Protection Act, which reflects the Senate's original health care reform bill, provides the overall framework for reform. The Reconciliation Act was drafted in the House to make changes to the Patient Protection Act, especially in the area of cost-sharing and in some of the revenue raisers.

Employer responsibility

The final health care package, unlike earlier versions, does not include an employer mandate. However, any employer with more than 50 full-time employees that does not offer health insurance and has at least one full-time employee receiving a premium assistance tax credit or cost-sharing will pay a per-employee penalty. An employer with more than 50 full-time employees that offers coverage that the government deems unaffordable or fails to meet minimum standards and has at least one full-time employee receiving a premium assistance tax credit or cost-sharing also will pay a per-employee penalty. Small employers with less than 50 employees will not be penalized in any case. The penalty rules apply starting in 2014.

Small employers that provide health insurance coverage are eligible for a new tax credit. A sliding scale tax credit is available immediately in 2010 for qualified small employers. The IRS is expected to make guidance for the new credit a priority. If your small business offers or is thinking of offering health insurance to your workers, the credit could generate significant cost-savings. Please contact our office and we can discuss the details of the credit in depth.

Individual responsibility

Unlike employers, individuals have a mandate under the health care reform package. Beginning in 2014, most individuals will be responsible for maintaining health insurance coverage for themselves and their dependents. If they do not have minimum essential coverage, they will be liable for a penalty.

The health care package excludes many individuals from the mandatory coverage requirement. Any individual or family who currently has coverage can retain that coverage under a "grandfather" provision. Individuals with incomes below the federal filing threshold, religious objectors, individuals covered by Medicaid and Medicare and others are also exempt.

The health care package provides a premium assistance tax credit and cost-sharing to help make coverage more affordable. The premium assistance tax credit is calculated on a sliding scale based on the individual's income in relation to the federal poverty level. Cost-sharing reduces the cost of coverage for qualified individuals. The premium assistance tax credit and cost-sharing generally will be available after 2013.

High-dollar plans

One of the principal revenue raisers to fund health care reform is a new excise tax on high-dollar health insurance plans. The health care reform package imposes an excise tax of 40 percent on insurance companies or plan administrators for any health insurance plan with an annual premium in excess of $10,200 for individuals and $27,500 for families. The excise tax applies to the amount in excess of the $10,200/$27,500 levels. The thresholds are higher for individuals in high-risk occupations and individuals over age 55. The excise tax will not kick in until 2018.

Medicare additional tax and surtax

Changes to the hospital insurance (HI)(Medicare) tax also fund health care reform. These changes impact higher-income individuals and families.

The health care reform package increases the Medicare tax by 0.9 percent for individuals who receive wages in excess of $200,000 (the threshold increases to $250,000 for married couples who file a joint federal income tax return). Additionally, the new law imposes a 3.8 percent surtax (called the Unearned Income Medicare Contribution) on investment income for individuals with adjusted gross incomes above $200,000 ($250,000 for married couples filing jointly). Investment income includes income from interest and dividends.

The additional Medicare tax on wages and the additional Medicare contribution on investment income take effect in 2013, so taxpayers have some time to prepare. Please contact our office for more details about how these tax changes may impact you.

Flexible spending arrangements

Flexible spending arrangements (FSAs) are a very popular way to save and pay for health care expenses. One of the most attractive features is the ability to use FSA dollars for over-the-counter medications. The health care reform package ends that feature after 2010.

In 2011 and subsequent years, FSA dollars can only be used to pay for prescription medications (with some limited exceptions). In 2013, the health care reform package limits the amount of contributions to health FSAs to $2,500 per year. The $2,500 amount will be indexed for inflation after 2013.

More provisions

The health care reform package als

• Increases the AGI threshold for claiming the itemized deduction for medical expenses for regular tax purposes to 10 percent after 2012 with a delayed effective date for seniors;
• Extends dependent coverage up to age 26;
• Expands Medicaid eligibility;
• Requires states to establish insurance exchanges to help individuals and small employers obtain coverage;
• Increases the additional tax on distributions from health savings accounts (HSAs) not used for qualified medical expenses;
• Eliminates the employer deduction for Medicare Part D;
• Imposes annual fees on pharmaceutical manufacturers and health insurance providers;
• Imposes an excise tax on medical device manufacturers;
• Requires more corporate information reporting;
• Imposes new requirements on non-profit hospitals;
• Accelerates some corporate estimated income taxes in 2014;
• Imposes an excise tax on indoor tanning services;
• Codifies the economic substance doctrine; and
• Modifies the biofuel credit.

In the coming months and years, the IRS and other federal agencies will issue many new rules and regulations to implement health care reform. Our office will keep you posted of developments, and, as always, please contact us if you have any questions.

In response to the economic downturn that has affected the retirement portfolios of millions of individuals across the country, Congress has been considering a variety of alternatives to offer relief to those who face financial emergencies and need immediate access to their funds. Two of the most significant proposals that have been recommended include: (1) significant broadening of the suspension of the 10 percent penalty tax on early withdrawals from IRAs and defined contribution plans, and (2) extending the temporary suspension of the penalty tax imposed on individuals age 70 1/2 or older who do not take required minimum distributions (RMDs) from certain retirement plans.

Early withdrawal penalty

To discourage individuals from using money set aside in retirement accounts for expenses incurred outside of retirement, a 10 percent tax is imposed on the amount that is withdrawn, in addition to this amount being included in the individual's gross income and subject to federal (and often, state) income tax. The 10 percent penalty will not apply to distributions made in the following circumstances:

• After the individual has reached age 59 1/2;
• The distribution is made to an individual who is a beneficiary of a deceased IRA owner;
• The individual is disabled;
• For higher education expenses (from IRAs only);
• The distributions are made as part of substantially equal payments over the account holder's life expectancy;
• The individual retires after age 55;
• For unreimbursed medical expenses exceeding 7.5 percent of the individual's adjusted gross income (AGI);
• For medical insurance premiums in the case of unemployment;
• To buy, build, or rebuild a first home (from IRAs only, and subject to a $10,000 withdrawal limit); and
• If the individual is a reservist called to active duty after September 11, 2001.

Caution: The extent to which a withdrawal may be made from an employer-sponsored qualified retirement plan, even with respect to amounts that you contributed, depends upon what is allowed under the written plan itself. Some plans only allow you to withdraw after retirement. Others allow withdrawals for "hardships," which may include medical expenses or other financial crisis. Still other withdrawals, such as withdrawals for higher education or a first home purchase, are never allowed under IRS rules from an employer-sponsored plan.

The 10 percent penalty and, for that matter, the underlying taxable income generated from a withdrawal, do not apply if the funds are properly rolled over within a 60-day period from an employer-sponsored plan to an IRA or from one qualified plan or IRA to another.

Hardship withdrawals. Individuals who take a hardship withdrawal from their defined contribution plan must also pay the 10 percent penalty tax. A hardship is defined as an immediate and heavy financial need. Certain expenses are deemed to meet this definition, but even so, the penalty still applies.

Proposals to suspend the 10 percent penalty

Several proposals have been advanced by policymakers to eliminate or suspend the 10 percent early withdrawal penalty in certain situations. The proposals would generally add a paragraph to Internal Revenue Code Sec. 72(t) to eliminate the penalty in specific circumstances. Proposals include eliminating or suspending the 10 percent early withdrawal penalty for:

• Public safety employees who retire before the age of 55;
• Workers who are unemployed;
• Individuals affected by natural disasters;
• Homeowners at risk of having their mortgage foreclosed;
• Individuals who receive a hardship distribution from a retirement plan; and
• Individuals who have qualified adoption expenses.

RMDs

Individuals with certain qualified retirement plans, as well as traditional IRAs and 403(b) plans, are required to withdraw a certain amount ( a "required minimum distribution" or RMD) from the account each year after reaching age 70 1/2 (Roth IRAs are not subject to the RMD rules). The annual RMD is based on the account balance as of December 31 of the prior year and the account holder's life expectancy. Generally, RMDs must begin no later than April 1 of the year after you reach age 70 1/2.

Proposals to suspend RMDs

RMDs were suspended for 2009 only. RMDs must be taken for 2010 and beyond, unless Congress acts to suspend the RMD rules again. However policymakers have put forth various proposals to eliminate or suspend altogether the RMD requirements. The proposals include:

• Suspending the RMD requirement through 2010;
• Suspending the RMD requirement through 2012;
• Eliminating the RMD requirement; or
• Postponing the required starting date, which would raise the age at which individuals must start taking their RMDs.

When contemplating whether to implement any of these proposals, Congress and Treasury officials must balance a number of considerations, including the immediate financial needs of individuals with the policies behind the penalty taxes; namely, providing funds for retirement and not allowing the money to be used for pre-retirement expenses.

Our office will keep you posted on any legislative proposals that may affect your retirement planning. We also can help you navigate the current rules that would apply should you need to make a withdrawal soon from your retirement savings.

Beginning in 2010, the income limitations that have prevented taxpayers with modified adjusted gross incomes of $100,000 or more and married taxpayers that filed their returns separately from converting a traditional individual retirement account (IRA) to a Roth IRA are eliminated entirely. As a bonus to kick off "unlimited Roth conversions," any income tax payments due on 2010 conversions may be deferred into 2011 and 2012. For higher-income individuals, 2010 presents a long-awaited and much anticipated opportunity to convert their savings into a Roth IRA providing tax-free distributions during their retirement years.

Eligibility for a Roth conversion in 2010 does not automatically make it a good decision for every taxpayer. Indeed, under the right circumstances, converting to a Roth IRA can provide potential significant tax and financial benefits. But every individual's needs and circumstances are unique, and a Roth IRA conversion must be assessed in light of your particular tax and financial situation. In addition, converting to a Roth IRA is not a "do-it-yourself" transaction, and you should consult with a tax professional about the benefits and drawbacks relating to your personal situation.

The new conversion opportunity does not apply to funds held in a 401(k). The conversion opportunity applies to traditional IRAs, in addition to SIMPLE IRAs and SEP plans.

Conversion methods

A conversion to a Roth IRA may generally be accomplished by one of three means:

-- Rollover. An IRA rollover involves making an eligible distribution from your traditional IRA that is rolled over into a Roth IRA within 60 days after the distribution. If the rollover does not occur within 60 days, it will be treated as an early withdrawal subject to a 10 percent early withdrawal tax as well as federal (and possible state) income taxation.

-- Trustee-to-trustee transfer. If your IRA trustee is the same trustee for your traditional IRA and Roth IRA, you may have that trustee make the account transfer on your behalf. Additionally, if the trustee is not the same, your traditional IRA trustee can also transfer the funds to your new, Roth IRA trustee on your behalf, even if they are not the same trustee for the accounts.

-- Account redesignation.

Regardless of type of means you use to convert to a Roth IRA, amounts converted from a non-Roth IRA to a Roth IRA are treated as distributed from the non-Roth IRA and rolled over to the Roth IRA. As mentioned above, a rollover must generally be effectuated within 60 days.

Income tax consequences

The government is encouraging Roth conversions not only to shore up retirement savings but also to gain short time revenues. It accomplishes the latter because a conversion from a traditional IRA is counted as a taxable distribution in which income taxes must be paid. Unlike such distributions outside of a Roth conversion, however, no early withdrawal penalty is imposed. Since you would be taxed on your traditional IRA distributions eventually anyway upon retirement, having the distribution taxed at the time of a Roth conversion can be viewed as an acceleration of that tax. In return, however, the funds that become part of your Roth account, including future earnings of them, become tax free forever into the future.

For conversions taking place in 2010, you have the option to elect to recognize the taxable income generated on the conversion amount ratably in adjusted gross income (AGI) in 2011 and 2012, instead of recognizing it all in 2010. This election does not spread the tax that would otherwise be paid in 2010 to 2011 and 2012; rather, it spreads the income realized in 2010, half into 2011 and half into 2012. That income, half in 2011 and half in 2012, is taxed at 2011 and 2012 rates, respectively, along with any other income normally realized for those years. It is important to "do the math" on this election before making any decision.

Conversion transaction

The institution or brokerage at which you maintain your traditional IRA will generally have a Roth Conversion Form, or similar document, that you must fill out to complete the transaction. The form may ask you for the name and account number of the IRA that you want to convert, whether you want to convert the entire amount of the traditional IRA, or only a part of the account, and the amount of the IRA you want to convert to the Roth IRA (or number of shares). Typically, the form will also inform your federal and state income tax withholding obligations regarding the transaction. You will have the opportunity to elect withholding, or elect not to have anything withheld from the funds in order to meet your anticipated income tax obligations from the transaction.

Note. Whether you pay the taxes on the transaction from the funds transferred to the Roth IRA itself, or with outside funds, is an important decision you make. In general, taxpayers are better off paying the tax, if they can, with funds outside the account. You should discuss the taxation aspect of the conversion with your tax advisor.

The Worker, Homeownership, and Business Assistance Act of 2009 (2009 Worker Act), enacted November 6, 2009, gives all businesses (or their owners in the case of pass-through entities) an opportunity to obtain a quick refund from the IRS using net operating losses (NOL). A company has an NOL when its business deductions for the year exceed its business income. Normally, a business can only carry back an NOL two years. But the new law allows any business to elect to carry back its NOLs from 2008 or 2009 for up to five years, regardless of form (corporation, individual, estate or trust) and size. (Partnership and S corporation NOLs flow through to partners and shareholders and can't be carried over by the entity.)

You don't have to make the election until the due date (including extensions) for filing your last 2009 return.For a calendar year taxpayer, this means the election does not have to be made until September 15, 2010 (for a corporation) or until October 15, 2010 (for an individual).

In electing the extended carryback provision, you must determine:

• Whether (if applicable) to revoke a previous election to waive the two-year carryback period, so that you can use the extended carryback;
• Whether to apply the extended carryback to 2008 NOLs or 2009 NOLs, because you can only elect the extended carryback for one year;
• Whether to carry back the NOL for three, four or five years;
• When to apply for the refund; and
• The IRS procedures for making the election.

You need to "crunch the numbers" and then take appropriate action.

Do the math for 2008

The 2008 calendar year is over. Calendar-year taxpayers have filed their returns. You know whether you have an NOL for 2008.Now it's time to dig out your old returns and your calculator. You can carry back the 2008 NOL up to five years, as far back as 2003.This is only useful if you had taxable income in 2003, 2004, or 2005 that the NOL can offset. How much can you get back from the IRS?

If you need the refund immediately, go ahead and claim it based on your 2008 NOLs.But if you can afford it, wait until you have your 2009 results, and then choose which year to carry back.

If you are a small business (average gross receipts of $15 million or less for three years), an earlier law allowed you to elect an extended carryback for 2008 NOLs. The election deadline for calendar year taxpayers -- the due date for the 2008 return -- has passed. But there's no harm. Unlike larger businesses, who must choose between 2008 and 2009, the new law gives you another extended carryback election for 2009 NOLs.

2009 NOLs - some planning still available

If 2009 is not yet over, you can do some tax planning to increase your 2009 business losses and NOL. This includes conventional techniques for accelerating deductions, recognizing losses, deferring income and avoiding gains. Claim bonus depreciation, for example. Or perhaps you can write off a worthless stock loss or a worthless debt.

A more sophisticated technique to increase losses is to change your accounting methods.Changing depreciation methods or valuation of inventory, for example, is a change of accounting method.If you need the IRS's consent, you still have until the end of 2009 to request the change.If IRS consent is automatic, you have until the filing date of your 2009 return to make the change, the same as the deadline for electing the extended carryback.

Properly elect the carryback and claim a refund

Ordinarily, taxpayers can claim a "quick" refund by filing Form 1045 (individuals) or Form 1139 (corporations).If you file the appropriate form within 12 months after the end of the tax year, the IRS will do a quick review and generally pay your refund within 45 days.If you need more time to file for a refund, you can file an amended return (Form 1040-X for an individual; Form 1120-X for a corporation).

Making an election to use the extended carryback is a separate matter from filing your claim for refund. You need to follow the IRS's instructions for making the election. You have ample time to make the election (for a calendar year taxpayer, the deadline is late 2010), so you want to follow the proper procedures. Otherwise, your election may be rejected or your refund claim may be delayed.

The IRS has now issued procedures for making the election. The election can be made on the return filed for the year of the NOL (e.g. Form 1040 or Form 1120), on an amended return for that year, or on a claim for a tentative refund (Form 1045 or Form 1139). You must attach a statement indicating that the taxpayer is electing the extended carryback and is not a TARP (Troubled Asset Relief Program) recipient. The statement must specify the length of the carryback period you are electing (three, four, or five years).

If the taxpayer previously claimed a two-year carryback or elected to waive the carryback period, the statement must indicate that the election amends a previous carryback claim or that the taxpayer is revoking the waiver.

If you would like to discuss these matters, please contact our office. We can help you consider your options.

During economic downturns, many people often look for ways to supplement their regular employment compensation. Or, you may be engaging in an activity - such as gambling or selling items on an online auction - that is actually earning you income: taxable income. Many individuals may not understand the tax consequences of, and reporting requirements for, earning these types of miscellaneous income. This article discusses how you report certain types of miscellaneous income.

Reporting your miscellaneous taxable income

For most people, gambling winnings and hobby income are uncommon types of taxable income. Gambling winnings and hobby income, as well as prizes and awards, represent "miscellaneous income" and are reported on Line 21 of your Form 1040 as "other income."

Hobby income

Hobbies are generally considered under the tax law as activities that are not pursued "for profit." However, the tax law provides that if your hobby shows a profit in at least three of the last five tax years, including the current year, you are assumed to be trying to make money. However, you can rebut the assumption -- that you are not out to run a profitable business even if you regularly have losses -- with evidence to the contrary. Just because you love what you are doing in a sideline business does not mean it's a hobby for tax law purposes. In fact, one secret to business success is often enjoying your work. Profits you receive from an activity that is a hobby and not a for-profit business are reported as "other income" on Line 21 of your Form 1040.

Hobby losses and expenses

You cannot deduct your hobby expenses in excess of income you derived from the hobby, and you can only deduct qualifying expenses if you itemize your deductions. Expenses that you incurred in generating hobby income are generally deductible as miscellaneous itemized deductions, subject to the two-percent floor, on Schedule A. If you incurred losses in connection with your hobby activities, you may generally be able to deduct these "hobby losses" but only to the extent of income produced by the activity.

However, some expenses that are deductible whether or not they are incurred in connection with a hobby (such as taxes, interest and casualty losses) are deductible even if they exceed hobby income. These expenses, however, will reduce the amount of your hobby income against which your hobby expenses can be offset. Your hobby expenses then offset the reduced income in the following order:

1. Operating expenses, generally;

2. Depreciation and other basis adjustment items.

As mentioned above, your itemized deduction for hobby expenses is subject to the two-percent floor on miscellaneous itemized deductions.

Gambling winnings

Gambling winnings, whether legal or illegal, are included in your gross income. If you have winnings from a lottery, raffle, or other types of gambling activities, you must report the full amount of your winnings on Line 21 of your Form 1040 as "other income." The taxable gains are the amount by which your winnings exceed the amount you wagered. If any taxes were withheld from your winnings, you should receive a Form W-2G showing the total paid to you in Box 1, and the amount of income taxes withheld in Box 2. You need to include the amount in Box 2 in the amount of taxes paid on Line 59 of your 1040.

Gambling losses

You can deduct your gambling losses as an itemized deduction for the year on Schedule A (Form 1040), line 28. However, you cannot deduct gambling losses that exceed your winnings. Thus, you can deduct losses from gambling up to the amount of your gambling winnings. You cannot reduce your gambling winnings by your gambling losses and report the difference. You must report the full amount of your winnings as income and claim your losses (up to the amount of winnings) as an itemized deduction. Therefore, your records should show your winnings separately from your losses.

You can reduce your gambling winnings by your wagering losses regardless of whether the underlying transactions are legal or illegal. Moreover, gambling losses may be offset against all gains arising out of wagering transactions, and not merely against gambling winnings. However, gambling losses can only be used to offset gambling gains during the same year.

Moreover, you cannot use your gambling losses to reduce taxable income from non-gambling sources, and they cannot be used as a carryover or carryback to reduce gambling income from other years. For example, the value of complimentary goods you might receive from a casino as an inducement to gamble are gains from which gambling losses can be deducted.

Casinos, lotteries and other payers of gambling winnings of $600 or more ($1,200 for bingo or slot machines and $1,500 for keno) report the winnings on Form W-2G, Certain Gambling Winnings.

If you have any questions about tax and reporting requirements in connection with hobby activities and other sources of income, please call our office.

If you have completed your tax return and you owe more money than you can afford to pay in full, do not worry, you have many options. While it is in your best interest to pay off as much of your tax liability as you can, there are many payment options you can utilize to help pay off your outstanding debt to Uncle Sam. This article discusses a few of your payment options.

Pay Uncle Sam as much as you can

First and foremost, if you cannot pay the full amount of taxes due, you should nevertheless file your return by the April 15 deadline. Moreover, you should send in as much money as you can with your return. The IRS assesses failure-to-file penalties so you should file your return despite being unable to pay the full amount with the return. As such, it's to your benefit to file your return by its due date and pay off any outstanding balance as soon as you can in order to minimize interest and penalties.

Payment options

If you are not able to pay the full amount of tax you owe, you have options. While you can obtain an automatic six-month extension of time to file, the IRS will still assess interest on the outstanding unpaid tax liability. To do so, you must file Form 4868, Application for Automatic Extension of Time To File U.S. Income Tax Return, by the due date for filing your calendar year return (typically April 15) or fiscal year return. However, an extension of time to file is not an extension of the time to pay your taxes. Penalties and interest continue to accrue during the extension.

Second, consider paying some or all of your tax liability by credit card or obtaining a cash advance on your credit card. The interest rate your credit card or bank charges (plus applicable fees) may be lower than the total amount of interest and penalties imposed by the IRS under the Tax Code.

You may also be eligible to take advantage of the IRS's monthly installment agreement option. This option allows eligible taxpayers to pay off their tax bill over a period of time - in monthly installments - to the IRS. However, if you have entered into an installment agreement during the preceding 5 years you cannot use this option. Additionally, even while you are making payments through an installment agreement, penalties and interest continue on the unpaid portion of that debt. To request an installment plan, you can use Form 9465, Request For Installment Agreement. Or, you can use the Online Payment Agreement (OPA) application.

There are many options for paying off your tax debt. Our office can discuss the payment options that will work best in your specific circumstances. Please don't hesitate to call our office with questions.

Education continues to become increasingly expensive. 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. Some people are surprised at what is available these days, as the dust settles on tax rules that have been in transition now for a number of years. A good place to start educating yourself on these education-related tax incentives - to help yourself or a member of your family better tackle the rising expense of education - is right here.

Education continues to become increasingly expensive. 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. Some people are surprised at what is available these days, as the dust settles on tax rules that have been in transition now for a number of years. A good place to start educating yourself on these education-related tax incentives - to help yourself or a member of your family better tackle the rising expense of education - is right here.

Hope scholarship and Lifetime Learning credits

The Hope (temporarily enhanced and renamed the "American Opportunity Tax Credit" for 2009 and 2010 by the American Recovery and Reinvestment Act of 2009) and Lifetime Learning credits can 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 American Opportunity Tax Credit, just like the Hope credit, and Lifetime Learning credit can not 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 for that year. Expenses that do not count towards the Lifetime Learning credit are those incurred to purchase books, supplies and other equipment, and charges and fees associated with meals and lodging. However, the American Opportunity Tax Credit can be claimed for course materials for 2009 and 2010 only.

Moreover, the American Opportunity Tax Credit (unlike the Hope credit) is available for expenses incurred during all four years of college, as provided under the 2009 Recovery Act. The Hope credit is only available for the first two years of college). However, the Lifetime Learning credit can be claimed for all years of postsecondary school (as well as for courses to acquire or improve job skills). In effect, the Lifetime Learning credit can pick up where the Hope credit left off.

The maximum American Opportunity Credit that can be claimed in 2009 and 2010 is $2,500 (previously $1,800 under the Hope credit) of qualified education expenses per student. Under the new credit, the maximum $2,500 per year would be allowed on $4,000 in qualifying payments (100 percent of the first $2,000 and 25 percent of the next $2,000).

For 2009 and 2010, the American Opportunity Tax Credit begins to phase-out when modified adjusted gross income (MAGI) reaches $80,000 for individuals (and $160,00 for joint filers). For 2009, the amount of the Lifetime learning credit phases out for individuals when MAGI reaches $50,000 for individuals and $100,00 for joint filers.

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 taxpayer/contributor's modified AGI.  

Student loan interest

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 in this case 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. For 2009, the amount of the deduction begins to phase out when an individual's modified AGI exceeds $60,000 a year (or $120,000 for married couples filing jointly). The deduction is completely eliminated once an individual's modified AGI reaches $75,000 (or $150,000 for joint filers). For all other taxpayers, the deduction phases out when AGI reaches $60,000 (and is eliminated completely at AGI of $75,000). If you are claimed as a dependent on another's tax return, you can not take the deduction, however.

IRA and 401(k) 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 a distribution from your IRA before you reach age 59 1/2 and not be subject to the 10 percent additional tax, 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.

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.

If you have a 401(k) plan that allows "hardship withdrawals" to be taken to pay for certain higher education expenses, such as tuition and other education expenses, you may consider taking such a distribution to pay for the education expenses for yourself, or your spouse or your children.  

Section 529 college savings plans

An often touted way to pay for college is through a state college savings plan (aka Section 529 plans, or qualified tuition plans). Section 529 plans allow 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 return. Moreover, distributions 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.

For 2009 and 2010, beneficiaries of qualified tuition plans can use tax-free distributions to pay for computers and computer technology, including internet access. This is courtesy of the American Recovery and Reinvestment Act of 2009.

Special needs education

The cost for a mentally or physically handicapped individual to attend a special school may be deductible as a medical expense if the principal reason for the individual attending the school is to help overcome or alleviate his or her disability. To qualify for the deduction, the individual does not have to attend a "special school." According to the IRS, the costs of a special education program at any school may be deductible if the program is primarily targeted to the individual's disability. Other deductible medical expenses may include the costs of transportation for the special education, summer school, tutoring, and meals and lodging at the school.

However, remember that medical expenses are only deductible to the extent they exceed 7.5 percent of your income, as an itemized deduction. Individuals with special needs children might also consider Coverdell Education Savings accounts as a vehicle for saving and paying for their children's special education expenses.

Private secondary and nursery school expenses

Private secondary expenses are generally not deductible. Furthermore, the IRS has ruled that any expenses allocated to high school tuition related to advance-placement college credit courses are still considered secondary tuition expenses and will not be counted toward the Hope or Lifetime learning credits.

"After-school" or "extended-day" programs, however, may be deductible if taken toward the child and dependent care credit for a child under age 13 to enable both spouses to work.  Expenses incurred to send a child to nursery school, pre-school or similar programs for children below the kindergarten level qualify fully for the child and dependent care credit without any requirement to separate by time or otherwise the educational portion of the expenses from the child care expenses.

The child and dependent care tax credit is a popular credit that, in part, enables you and your spouse (if married) to reduce your taxes by the cost of certain qualifying expenses you incur to have someone care for your child or childrenwho are under the age of 13 so that you can work or look for work. For 2009, you can generally claim up to $3,000 of expenses paid in the year for one qualifying individual, or $6,000 for two or more qualifying individuals, under the dependent and child care credit. Additional income and eligibility limitations apply.

If you have any questions on how these rules apply to your education expenses, please do not hesitate to call our offices.

To ease the pain of the ever-escalating costs of healthcare, many employers provide certain tax-driven health benefits and plans to their employees. To help employers understand the differences and similarities among three popular medical savings vehicles - health savings accounts (HSAs), flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs) - here's an overview.

Health Savings Accounts (HSAs)

HSAs are relatively new. An HSA is a tax-exempt trust or custodial account that is established exclusively to pay for (or reimburse) the qualified medical expenses of the account holder (typically an employee), a spouse or dependents such as children. Individuals get to take an above-the-line deduction for HSA contributions, while employer contributions to an employee's HSA are neither included in the employee's gross income nor subject to employment taxes. HSA earnings grow tax-free and distributions to pay for qualified medical expenses are also tax-free.

For 2008, a deduction may be taken up to $2,900 by individuals with self-only coverage and $5,800 by individuals with family coverage. And, individuals age 55 or older may make additional "catch-up" contributions to an HSA.

HSA contributions in an account carry over from year to year until the employee uses them. HSAs are also portable, meaning that an employee can take their funds when they leave or change jobs.

To be eligible for an HSA, an individual must generally:

• Have a high deductible health plan (HDHP);
• Have no other health coverage except for certain types of permitted coverage (for example, coverage for accidents, disability, dental and vision care, and long-term care);
• Not be enrolled in Medicare; and
• Not be able to be claimed as a dependent on another person's tax return.

HDHPs feature higher annual deductibles than other traditional health plans. For 2008, the minimum HDHP deductible is $1,100 for self-only coverage, and $2,200 for family coverage. HSA annual contributions, however, are not limited to the annual deductible under an HDHP.

Flexible Spending Arrangements (FSAs)

An FSA is an employer-provided benefit program that reimburses employees for specified expenses as they are incurred. Employees must first incur and substantiate the expense before it is reimbursed by the employer. FSAs are also known as "cafeteria plans" or "Section 125 plans" because they are allowed under Code Sec. 125 of the Internal Revenue Code. An FSA allows employees to contribute before-tax dollars to the account to be used to reimburse health care costs. Employers can also contribute to an employee's FSA. Generally, distributions may only be made to reimburse an employee for qualified medical expenses. They generally cannot be carried forward from year to year; specific "use-it-or-lose-it" rules apply.

Funds set aside in an FSA, typically through a voluntary salary reduction agreement, are not included in an employee's gross income or subject to employment taxes (with an exception for employer contributions used to pay for long-term care insurance). Withdrawals from an FSA are tax-free if used for qualified medical expenses. Employees can also withdraw funds from their account to pay for qualified medical expenses even if they have not yet placed the funds in the FSA.

Health Reimbursement Arrangements (HRAs)

An HRA is a type of FSA in which an employer sets aside funds to reimburse employees for qualified medical expenses up to a maximum dollar amount. Employer HRA contributions are not included in employees' gross income or subject to employment taxes. Additionally, employers get to deduct amounts contributed to employees' HRAs. HRAs can only be established and funded by an employer, and can be offered together with other employer-provided health benefits. Self-employed individuals are not eligible for HRAs.

Generally, there is no limit on the amount an employer can contribute to an employee's HRA, and any unused amounts in an HRA can be carried forward to later years. HRAs, however, are not portable and therefore do not follow employees if they change employment.

Distributions from HRAs can only be used to pay for qualified medical expenses that an employee has incurred on or after the date he or she enrolled in the HRA. If a distribution is made to pay for non-qualified medical expenses, those amounts are included in the employee's gross income. Moreover, distributions made to someone other than the employee, their spouse or dependents are taxable income.

If you need further analysis of which of these health-benefit plans may be right for you, and your employees if applicable, please call us.

The IRS allows taxpayers with a charitable inclination to take a deduction for a wide range of donated items. However, the IRS does provide specific guidelines for those taxpayers contributing non-cash items, from the type of charity you can donate to in order to take a deduction to the quality of the goods you contribute and how to value them for deduction purposes. If your summer cleaning has led, or may lead, you to set aside clothes and other items for charity, and you would like to know how to value these items for tax purposes, read on.

Household items that can be donated to charitable, and for which a deduction is allowed, include:

• Furniture;
• Furnishings;
• Electronics;
• Appliances;
• Linens; and
• Similar items.

The following are not considered household items for charitable deduction purposes:

• Food;
• Paintings, antiques, and other art objects;
• Jewelry; and
• Collections.

Valuing clothing and household items

Many people give clothing, household goods and other items they no longer need to charity. If you contribute property to a qualified organization, the amount of your charitable contribution is generally the fair market value (FMV) of the property at the time of the contribution. However, if the property has increased in value since you purchased it, you may have to make some adjustments to the amount of your deduction.

You can not deduct donations of used clothing and used household goods unless you can prove the items are in "good," or better, condition; and in the case of equipment, working. However, the IRS has not specifically set out what qualifies as "good" condition.

Fair market value is the amount that the item could be sold for now; what you originally paid for the clothing or household item is completely irrelevant. For example, if you paid $500 for a sofa that would only get you $50 at a yard sale, your deduction for charitable donation purposes is $50 (the sofa's current FMV). You cannot claim a deduction for the difference in the price you paid for the item and its current FMV.

To determine the FMV of used clothing, you should generally claim as the value the price that a buyer of used clothes would pay at a thrift shop or consignment store.

Comment. In the rare event that the household item (or items) you are donating to charity has actually increased in value, you will need to make adjustments to the value of the item in order to calculate the correct deductible amount. You may have to reduce the FMV of the item by the amount of appreciation (increase in value) when calculating your deduction.

Good faith estimate

All non-cash donations require a receipt from the charitable organization to which they are donated, and it is your responsibility as the taxpayer, not the charity's, to make a good faith estimate of the item's (or items') FMV at the time of donation. The emphasis on valuation should be on "good faith." The IRS recognizes some abuse in this area, yet needs to balance its public ire with its duty to encourage legitimate donations. While the audit rate on charitable deductions is not high, it also is not non-existent. You must be prepared with reasonable estimates for used clothing and household goods, high enough so as not to shortchange yourself, yet low enough to prevent an IRS auditor from threatening a penalty.

In any event, if the FMV of any item is more than $5,000, you will need to obtain an appraisal by a qualified appraiser to accompany your tax form (which is Form 8283, Noncash Charitable Contributions). When dealing with valuables, an appraisal helps protect you as well as the IRS.

If you have questions about the types of items that you can donate to charity, limits on deductibility, or other general inquiries about charitable donations and deductions, please contact out office.

Often, individuals end up with an unexpected tax liability on April 15. There are several options available to pay off your tax debt, stop accruing penalties and interest and secure peace of mind. Each payment method has its advantages and disadvantages depending on your financial, and personal, circumstances, and each option should be discussed with a tax professional prior to making a decision. Our office would be glad to answer any questions you have about each payment method.  

Stop accruing interest and penalties

Remember, if you filed on time but were unable to pay the entire amount, or any amount, showing as due on your return when you filed, and you have an outstanding balance with Uncle Sam, you are incurring interest and a "failure to pay" penalty imposed by the IRS. The failure to pay penalty is one-half of one percent (0.5%) owed for each month, or part of a month, that your tax remains unpaid after the due date. The late payment penalty can climb to a maximum of 25 percent on the amount actually shown as due on the return, even if you paid some of the tax debt off when you filed your return. This is the reason why it is imperative that you pay off your tax debt as quickly as possible, under a plan that avoids this steep penalty.

Here are some of the most common payment options available to taxpayers who still have an outstanding balance with the IRS:

Pay by credit card. Depending on your situation, paying the balance of your tax liability with a credit card (or by another form of personal loan) may be the best option in order to stop accruing interest and penalties for failing to pay the entire amount due. If this is an option, make sure you use a card with the lowest interest rate and the lowest account balance. The IRS has contracted with two private, third-party servicers that process credit card tax payments, and both (Official Payments Corporation and Link2Gov Corporation) accept most major credit cards such as American Express, Visa, and MasterCard. Additionally, you can use a credit card regardless of whether you filed your return electronically or by mail. Finally, be mindful that interest on a credit card or other personal loan to pay off your taxes is non-deductible.

Apply for an installment plan. The IRS offers taxpayers the ability to apply for an installment agreement plan. There are many requirements and rules regarding the installment plan method, which a tax professional can discuss with you. A request for an installment plan is made by filing Form 9465 with the IRS. Although there is a fee for apply for the agreement of approximately $105, this amount is deducted from your first payment upon approval of your request. However, even if your request is granted, you will continue to be charged interest on any tax not paid by the due date. But, the late payment penalty will generally be half the usual rate (i.e. 2 percent, instead of 4 percent per month).

Offer in compromise. In some situations, the IRS may allow you to strike a deal by accepting an offer-in-compromise (OIC). In general, an OIC allows you to make a one-time lump sum payment to the IRS that is less than the total amount of the taxes you owe. However, if your tax debt can be fully paid through an installment agreement or by other means, in most cases you may not be eligible for an OIC. Additionally, the amount of tax you propose to pay must reasonably reflect the liability you actually owe to have any success of being accepted by the IRS. You must include a $150 application fee with your OIC request, which is made on Form 656. If the IRS accepts your offer, this amount goes towards reducing your tax liability.

These are only some of the common options available to taxpayers who remain saddled with unpaid tax debt. Each available payment option should be discussed with a tax professional. Our office can help you understand your options and choose a payment method that is best for you, personally and financially. 

If you've made, or are planning to make, a big gift before the end of 2009, you may be wondering what your gift tax liability, if any, may be. You may have to file a federal tax return even if you do not owe any gift tax. Read on to learn more about when to file a federal gift tax return.

When you must file

Most gifts you make are not subject to the gift tax. Generally, you must file a gift tax return, Form 709, U.S. Gift (and Generation-Skipping Transfer) Tax Return, if any of the following apply to gifts you have made, or will make, in 2009:

• Gifts you give to another person (other than your spouse) exceed the $13,000 annual gift tax exclusion for 2009.
• You and your spouse are splitting a gift.
• You gave someone (other than your spouse) a gift of a future interest that he or she cannot actually possess, enjoy or receive income from until some time in the future.

Remember, filing a gift tax return does not necessarily mean you will owe gift tax.

Gifts that do not require a tax return

You do not have to file a gift tax return to report three types of gifts: (1) transfers to political organizations, (2) gift payments that qualify for the educational exclusion, or (3) gift payments that qualify for the medical payment exclusion. Although medical expenses and tuition paid for another person are considered gifts for federal gift tax purposes, if you make the gift directly to the medical or educational institution, the payment will be non-taxable. This applies to any amount you directly transfer to the provider as long as the payments go directly to them, not to the person on whose behalf the gift is made.

Unified credit

Even if the gift tax applies to your gifts, it may be completely eliminated by the unified credit, also referred to as the applicable credit amount, which can eliminate or reduce your gift (as well as estate) taxes. You must subtract the unified credit from any gift tax you owe; any unified credit you use against your gift tax in one year will reduce the amount of the credit you can apply against your gift tax liability in a later year. Keep in mind that the total credit amount that you use against your gift tax liability during your life reduces the credit available to use against your estate tax.

Let's take a look at an example:

In 2009, you give your nephew Ben a cash gift of $8,000. You also pay the $20,000 college tuition of your friend, Sam. You give your 30-year-old daughter, Mary, $25,000. You also give your 27-year-old son, Michael, $25,000. Before 2009, you had never given a taxable gift. You apply the exceptions to the gift tax and the unified credit as follows:

• The qualified education tuition exclusion applies to the gift to Sam, as payment of tuition expenses is not subject to the gift tax. Therefore, the gift to Sam is not a taxable gift.
• The 2009 annual exclusion applies to the first $13,000 of your gift to Ben, Mary and Michael, since the first $13,000 of your gift to any one individual in 2009 is not taxable. Therefore, your $8,000 gift to Ben, the first $13,000 of your gift to Mary, and the first $13,000 of your gift to Michael are not taxable gifts.
• Finally, apply the unified credit. The gift tax will apply to $24,000 of the above transfers ($12,000 remaining from your gift to Mary, plus $12,000 remaining from your gift to Michael). The amount of the tax on the $24,000 is computed using IRS tables for computing the gift tax, which is located in the Instructions for Form 709. You would subtract the tax owe on these gifts from your unified credit of $345,800 for 2009. The unified credit that you can use against the gift tax in a later year (and against any estate tax) will thus be reduced. If you apply the unified credit to the amount of gift tax owe in 2009, you may not have to pay any gift tax for the year. Nevertheless, you will have to file a Form 709.

Filing a gift tax return

You must report the amount of a taxable gift on Form 709. For gifts made in 2009, the maximum gift tax rate is 45 percent. You can make an unlimited number of tax-free gifts in 2009, as long as the gifts are not more than $13,000 to each person or entity in 2009 (or $26,000 if you and your spouse make a gift jointly), without having to pay gift taxes on the transfers.

On December 18, 2007, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 (Mortgage Debt Relief Act), providing some major assistance to certain homeowners struggling to make their mortgage payments. The centerpiece of the new law is a three-year exception to the long-standing rule under the Tax Code that mortgage debt forgiven by a lender constitutes taxable income to the borrower. However, the new law does not alleviate all the pain of all troubled homeowners but, in conjunction with a mortgage relief plan recently announced by the Treasury Department, the Act provides assistance to many subprime borrowers.

Cancellation of debt income

When a lender forecloses on property, sells the home for less than the borrower's outstanding mortgage debt and forgives all, or part, of the unpaid debt, the Tax Code generally treats the forgiven portion of the mortgage debt as taxable income to the homeowner. This is regarded as "cancellation of debt income" (reported on a Form 1099) and taxed to the borrower at ordinary income tax rates.

Example. Mary's principal residence is subject to a $250,000 mortgage debt. Her lender forecloses on the property in 2008. Her home is sold for $200,000 due to declining real estate values. The lender forgives the $50,000 difference leaving Mary with $50,000 in discharge of indebtedness income. Without the new exclusion in the Mortgage Debt Relief Act, Mary would have to pay income taxes on the $50,000 cancelled debt income.

The Mortgage Debt Relief Act

The Mortgage Debt Relief Act excludes from taxation discharges of up to $2 million of indebtedness that is secured by a principal residence and was incurred to acquire, build or make substantial improvements to the taxpayer's principal residence. While the determination of a taxpayer's principal residence is to be based on consideration of "all the facts and circumstances," it is generally the one in which the taxpayer lives most of the time. Therefore, vacation homes and second homes are generally excluded.

Moreover, the debt must be secured by, and used for, the principal residence. Home equity indebtedness is not covered by the new law unless it was used to make improvements to the home. "Cash out" refinancing, popular during the recent real estate boom, in which the funds were not put back into the home but were instead used to pay off credit card debt, tuition, medical expenses, or make other expenditures, is not covered by the new law. Such debt is fully taxable income unless other exceptions apply, such as bankruptcy or insolvency. Additionally, "acquisition indebtedness" includes refinancing debt to the extent the amount of the refinancing does not exceed the amount of the refinanced debt.

The Mortgage Debt Relief Act is effective for debt that has been discharged on or after January 1, 2007, and before January 1, 2010.

Mortgage workouts

In addition to foreclosure situations, some taxpayers renegotiating the terms of their mortgage with their lender are also covered by the new law. A typical foreclosure nets a lender only about 60 cents on the dollar. When the lender determines that foreclosure is not in its best interests, it may offer a mortgage workout. Generally, in a mortgage workout the terms of the mortgage are modified to result in a lower monthly payment and thus make the loan more affordable.

More help

Recently, Treasury Department officials brokered a plan that brings together private sector mortgage lenders, banks, and the Bush Administration to help homeowners. The plan is called HOPE NOW.

Here's how it works: The HOPE NOW plan is aimed at helping borrowers who were able to afford the introductory "teaser" rates on their adjustable rate mortgage (ARM), but will not be able to afford the loan once the rate resets between 2008 and 2010 (approximately 1.3 million ARMs are expected to reset during this period). The plan will "freeze" these borrowers' interest rates for a period of five years. The plan, however, has some limitations that exclude many borrowers. Only borrowers who are current on their mortgage payments will benefit. Borrowers already in default or who have not remained current on their mortgage payments are excluded.

Under the HOPE NOW plan, borrowers may be able t

- Refinance to a new mortgage;

- Switch to a loan insured by the Federal Housing Authority (FHA);

- Freeze their "teaser" introductory rate for five years.

Without the Mortgage Debt Relief Act, a homeowner who modifies the terms of their mortgage loan, or has their interest rate frozen for a period of time, could be subject to debt forgiveness income under the Tax Code. This is why the provision of the Mortgage Debt Relief Act excluding debt forgiveness income from a borrower's income is a critical component necessary to make the HOPE NOW plan effective.

If you would like to know more about relief under the Mortgage Forgiveness Debt Relief Act of 2007 and the Treasury Department's plan, please call our office. We are happy to help you navigate these complicated issues.

Only "qualified moving expenses" under the tax law are generally deductible. Qualified moving expenses are incurred to move the taxpayer, members of the taxpayer's household, and their personal belongings. For moving expenses to be deductible, however, a move must:

(1) Be closely related to the beginning of employment;

(2) Satisfy the time test; and

(3) Satisfy the distance test.

The purpose of the move must be employment. The worker must be moving to a new job. However, the worker need not have obtained the job before moving.

The time test requires that the individual work full time for at least 39 weeks in the first 12 months following the move. Self-employed persons must work full-time for at least 30 weeks in the first 12 months following the move, and at least 78 weeks in the 24 months following the move. Full-time employment is determined by the time customary in the worker's trade or business. Employment and self-employment may be aggregated. With respect to married couples, only one spouse must satisfy this requirement.

Even if the time test is not satisfied at the end of the first tax year ending after the move, the qualified moving expenses may be deducted in the move year. If the time test is ultimately not satisfied, an amended return must be filed in the subsequent year using Form 1040X, Amended U.S. Individual Income Tax Return.

The distance test must also be satisfied. The new principal place of employment must be at least 50 miles further from the old residence than the prior principal place of employment. If the worker has multiple places of employment, the principal place of employment must be determined. This test is satisfied if the individual is moving to his or her first principal place of employment.

Special rules apply to moving expenses of active duty military personnel and their families. There are also special rules that apply to moves outside the United States.

If you are planning a move and would like advice on how to structure expenses to maximize your tax savings, please give this office a call.

If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

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If you use your car for business purposes, you may have learned that keeping track and properly logging the variety of expenses you incur for tax purposes is not always easy. Practically speaking, how often and how you choose to track expenses associated with the business use of your car depends on your personality; whether you are a meticulous note-taker or you simply abhor recordkeeping. However, by taking a few minutes each day in your car to log your expenses, you may be able to write-off a larger percentage of your business-related automobile costs.

Regardless of the type of record keeper you consider yourself to be, there are numerous ways to simplify the burden of logging your automobile expenses for tax purposes. This article explains the types of expenses you need to track and the methods you can use to properly and accurately track your car expenses, thereby maximizing your deduction and saving taxes.

Expense methods

The two general methods allowed by the IRS to calculate expenses associated with the business use of a car include the standard mileage rate method or the actual expense method. The standard mileage rate for 2017 is 53.5 cents per mile. In addition, you can deduct parking expenses and tolls paid for business. Personal property taxes are also deductible, either as a personal or a business expense. While you are not required to substantiate expense amounts under the standard mileage rate method, you must still substantiate the amount, time, place and business purpose of the travel.

The actual expense method requires the tracking of all your vehicle-related expenses. Actual car expenses that may be deducted under this method include: oil, gas, depreciation, principal lease payments (but not interest), tolls, parking fees, garage rent, registration fees, licenses, insurance, maintenance and repairs, supplies and equipment, and tires. These are the operating costs that the IRS permits you to write-off. For newly-purchased vehicles in years in which bonus depreciation is available, opting for the actual expense method may make particularly good sense since the standard mileage rate only builds in a modest amount of depreciation each year. For example, for 2017, when 50 percent bonus depreciation is allowed, maximum first year depreciation is capped at $11,160 (as compared to $3,160 for vehicles that do not qualify). In general, the actual expense method usually results in a greater deduction amount than the standard mileage rate. However, this must be balanced against the increased substantiation burden associated with tracking actual expenses. If you qualify for both methods, estimate your deductions under each to determine which method provides you with a larger deduction.

Substantiation requirements

Taxpayers who deduct automobile expenses associated with the business use of their car should keep an account book, diary, statement of expenses, or similar record. This is not only recommended by the IRS, but essential to accurate expense tracking. Moreover, if you use your car for both business and personal errands, allocations must be made between the personal and business use of the automobile. In general, adequate substantiation for deduction purposes requires that you record the following:

• The amount of the expense;
• The amount of use (i.e. the number of miles driven for business purposes);
• The date of the expenditure or use; and
• The business purpose of the expenditure or use.

Suggested recordkeeping: Actual expense method

An expense log is a necessity for taxpayers who choose to use the actual expense method for deducting their car expenses. First and foremost, always keep your receipts, copies of cancelled checks and bills paid. Maintaining receipts, bills paid and copies of cancelled checks is imperative (even receipts from toll booths). These receipts and documents show the date and amount of the purchase and can support your expenditures if the IRS comes knocking. Moreover, if you fail to log these expenses on the day you incurred them, you can look back at the receipt for all the essentials (i.e. time, date, and amount of the expense).

Types of Logs. Where you decide to record your expenses depends in large part on your personal preferences. While an expense log is a necessity, there are a variety of options available to track your car expenditures - from a simple notebook, expense log or diary for those less technologically inclined (and which can be easily stored in your glove compartment) - to the use of a smartphone or computer. Apps specifically designed to help track your car expenses can be easily downloaded onto your iPhone or Android device.

Timeliness. Although maintaining a daily log of your expenses is ideal - since it cuts down on the time you may later have to spend sorting through your receipts and organizing your expenses - this may not always be the case for many taxpayers. According to the IRS, however, you do not need to record your expenses on the very day they are incurred. If you maintain a log on a weekly basis and it accounts for your use of the automobile and expenses during the week, the log is considered a timely-kept record. Moreover, the IRS also allows taxpayers to maintain records of expenses for only a portion of the tax year, and then use those records to substantiate expenses for the entire year if he or she can show that the records are representative of the entire year. This is referred to as the sampling method of substantiation. For example, if you keep a record of your expenses over a 90-day period, this is considered an adequate representation of the entire year.

Suggested Recordkeeping: Standard mileage rate method

If you loathe recordkeeping and cannot see yourself adequately maintaining records and tracking your expenses (even on a weekly basis), strongly consider using the standard mileage rate method. However, taking the standard mileage rate does not mean that you are given a pass by the IRS to maintaining any sort of records. To claim the standard mileage rate, appropriate records would include a daily log showing miles traveled, destination and business purpose. If you incur mileage on one day that includes both personal and business, allocate the miles between the two uses. A mileage record log, whether recorded in a notebook, log or handheld device, is a necessity if you choose to use the standard mileage rate.

If you have any questions about how to properly track your automobile expenses for tax purposes, please call our office. We would be happy to explain your responsibilities and the tax consequences and benefits of adequately logging your car expenses.

These days, both individuals and businesses buy goods, services, even food on-line. Credit card payments and other bills are paid over the internet, from the comfort of one's home or office and without any trip to the mailbox or post office.

Now, what is probably your biggest "bill" can be paid on-line: your federal income taxes.

There are three online federal tax payment options available for both businesses and individuals: electronic funds withdrawal, credit card payments and the Electronic Federal Tax Payment System. If you are not doing so already, you should certainly consider the convenience -and safety-- of paying your tax bill online.  While all the options are now "mainstream" and have been used for at least several years, safe and convenient, each has its own benefits as well as possible drawbacks. The pros and cons of each payment option should be weighed in light of your needs and preferences.

Electronic Funds Withdrawal

Electronic funds withdrawal (or EFW) is available only to taxpayers who e-file their returns. EFW is available whether you e-file on your own, or with the help of a tax professional or software such as TurboTax. E-filing and e-paying through EFW eliminates the need to send in associated paper forms.

Through EFW, you schedule when a tax payment is to be directly withdrawn from your bank account. The EFW option allows you to e-file early and, at the same time, schedule a tax payment in the future. The ability to schedule payment for a specific day is an important feature since you decide when the payment is taken out of your account. You can even schedule a payment right up to your particular filing deadline.

The following are some of the tax liabilities you can pay with EFW:

• Individual income tax returns (Form 1040)
• Trust and estate income tax returns (Form 1041)
• Partnership income tax returns (Forms 1065 and 1065-B)
• Corporation income tax returns for Schedule K-1 (Forms 1120, 1120S, and 1120POL)
• Estimated tax for individuals (Form 1040)
• Unemployment taxes (Form 940)
• Quarterly employment taxes (Form 941)
• Employers annual federal tax return (Form 944)
• Private foundation returns (Form 990-PF)
• Heavy highway vehicle use returns (Form 2290)
• Quarterly federal excise tax returns (Form 720)

For a return filed after the filing deadline, the payment is effective on the filing date. However, electronic funds withdrawals can not be initiated after the tax return or Form 1040 is filed with the IRS. Moreover, a scheduled payment can be canceled up until two days before the payment.

EFW does not allow you to make payments greater than the balance you owe on your return. Therefore, you can't pay any penalty or interest due through EFW and would need to choose another option for these types of payments. While a payment can be cancelled up to two business days before the scheduled payment date, once your e-filed return is accepted by the IRS, your scheduled payment date cannot be changed. Thus, if you need to change the date of the payment, you have to cancel the original payment transaction and chose another payment method. Importantly, if your financial institution can't process your payment, such as if there are insufficient funds, you are responsible for making the payment, including potential penalties and interest. Finally, while EFW is a free service provided by the Treasury, your financial institution most likely charges a "convenience fee."

Credit Card Payments

Do you have your card ready? The Treasury Department is now accepting American Express, Discover, MasterCard, and VISA.

Both businesses and individual taxpayers can make tax payments with a credit card, whether they file a paper return or e-file. A credit card payment can be made by phone, when e-filing with tax software or a professional tax preparer, or with an on-line service provider authorized by the IRS. Some tax software developers offer integrated e-file and e-pay options for taxpayers who e-file their return and want to use a credit card to pay a balance due.

However, there is a convenience fee charged by service providers. While fees vary by service provider, they are typically based on the amount of your tax payment or a flat fee per transaction. For example, you owe $2,500 in taxes and your service provider charges a 2.49% convenience fee. The total fee to the service provider will be $62.25. Generally, the minimum convenience fee is $1.00 and they can rise to as much as 3.93% of your payment.

The following are some tax payments that can be made with a credit card:

• Individual income tax returns (Form 1040)
• Estimated income taxes for individuals (Form 1040-ES)
• Unemployment taxes (Form 940)
• Quarterly employment taxes (Form 941)
• Employers annual federal tax returns (Form 944)
• Corporate income tax returns (Form 1120)
• S-corporation returns (Form 1120S)
• Extension for corporate returns (Form 7004)
• Income tax returns for private foundations (Form 990-PF)

However, as is the case is with the EFW option, if a service provider fails to forward your payment to the Treasury, you are responsible for the missed payment, including potential penalties and interest.

Electronic Federal Tax Payment System

EFTPS is a system that allows individuals and businesses to pay all their federal taxes electronically, including income, employment, estimated, and excise taxes. EFTPS is available to both individuals and businesses and, once enrolled, taxpayers can use the system to pay their taxes 24 hours a day, seven days a week, year round. Businesses can schedule payments 120 days in advance while individuals can schedule payments 365 days in advance. With EFTPS, you indicate the date on which funds are to be moved from your account to pay your taxes. You can also change or cancel a payment up to 2 business days in advance of the scheduled payment date.

EFTPS is an ideal payment option for taxpayers who make monthly installment agreement payments or quarterly 1040ES estimated payments. Businesses should also consider using EFTPS to make payments that their third-party provider is not making for them.

EFTPS is a free tax payment system provided by the Treasury Department that allows you to make all your tax payments on-line or by phone. You must enroll in EFTPS, however, but the process is simple.

We would be happy to discuss these payment options and which may best suit your individual or business needs. Please call our office learn more about your on-line federal tax payment options.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

In order to be tax deductible, compensation must be a reasonable payment for services. Smaller companies, whose employees frequently hold significant ownership interests, are particularly vulnerable to IRS attack on their compensation deductions.

Reasonable compensation is generally defined as the amount that would ordinarily be paid for like services by like enterprises under like circumstances. This broad definition is supplemented, for purposes of determining whether compensation is deductible as an ordinary and necessary expense, by a number of more specific factors expressed in varying forms by the IRS, the Tax Court and the Circuit Courts of Appeal, and generally relating to the type and extent of services provided, the financial concerns of the company, and the nature of the relationship between the employee and the employer.

Why IRS Is Interested

A chief concern behind the IRS's keen interest in what a company calls "compensation" is the possibility that what is being labeled compensation is in fact a constructive dividend. If employees with ownership interests are being paid excessive amounts by the company, the IRS may challenge compensation deductions on the grounds that what is being called deductible compensation is, in fact, a nondeductible dividend.

Another area of concern for the IRS is the payment of personal expenses of an employee that are disguised as businesses expenses. There, the business is trying to obtain a business expense deduction without the offsetting tax paid by the employee in recognizing income. In such cases, a business and its owners can end up with a triple loss after an IRS audit: taxable income to the individual, no deduction to the business and a tax penalty due from both parties.

Factors Examined

The factors most often examined by the IRS in deciding whether payments are reasonable compensation for services or are, instead, disguised dividend payments, include:

1. The salary history of the individual employee
2. Compensation paid by comparable employers to comparable employees
3. The salary history of other employees of the company
4. Special employee expertise or efforts
5. Year-end payments
6. Independent inactive investor analysis
7. Deferred compensation plan contributions
8. Independence of the board of directors
9. Viewpoint of a hypothetical investor contemplating purchase of the company as to whether such potential investor would be willing to pay the compensation.

Failure to pass the reasonable compensation test will result in the company's loss of all or part of its deduction. Analysis and examination of a company's compensation deductions in light of the relevant listed factors can provide the company with the assurance that the compensation it pays will be treated as reasonable -- and may in the process prevent the loss of its deductions.

Note: In the case of publicly held corporations, a separate $1 million dollar per person cap is also placed on deductible compensation paid to the CEO and each of the four other highest-paid officers identified for SEC purposes. (Certain types of compensation, including performance-based compensation approved by outside directors, are not included in the $1 million limitation.)

The S Corp Enigma

The opposite side of the reasonable compensation coin is present in the case of some S corporations. By characterizing compensation payments as dividends, the owners of these corporations seek to reduce employment taxes due on amounts paid to them by their companies. In these cases, the IRS attempts to recharacterize dividends as salary if the amounts were, in fact, paid to the shareholders for services rendered to the corporation.

Caution. In the course of performing the compensation-dividend analysis, watch out for contingent compensation arrangements and for compensation that is proportional to stock ownership. While not always indicators that payments are distributions of dividends instead of compensation for services, their presence does suggest the possibility. Compensation plans should not be keyed to ownership interests. Contingent and incentive arrangements are also scrutinized by the IRS. The courts have frequently ruled that a shareholder has a built-in interest in seeing that the company is successful and rewarding him for increasing the value of his own property is inappropriate. Similar to the reasonable compensation test, however, this rule is not hard and fast. Accordingly, the rules followed in each jurisdiction will control there.

Conclusions

Determining whether a shareholder-employee's compensation is reasonable depends upon many variables, such as the contributions that employee makes to your business, the compensation levels within your industry, and whether an independent investor in your company would accept the employee's compensation as reasonable.

Please call our office for a more customized analysis of how your particular compensation package fits into the various rules and guidelines. Further examination of your practices not only may help your business better sustain its compensation deductions; it may also help you take advantage of other compensation arrangements and opportunities.

Businesses benefit from many tax breaks. If you are in business with the objective of making a profit, you can generally claim all your business deductions. If your deductions exceed your income for the year, you can claim a loss for the year, up to the amount of your income from other activities. Remaining losses can be carried over into other years.

These are very generous tax breaks and sometimes people establish a business to generate losses. They have no intention of ever earning a profit. Other times, they genuinely hope to earn a profit but never do.

The IRS calls these activities "hobbies."  Expenses from these activities are never deductible in excess of any income that is declared earned from them. Recently, the IRS issued a new warning in the form of a Fact Sheet (FS-2007-18) to educate taxpayers about the differences between a for-profit business and a hobby.

No bright line

There's no bright line to distinguish a genuine business with a profit motive from a hobby. Over the years, the IRS and the courts have developed a list of factors to determine if an activity has a profit motive or is a hobby. No one factor is greater than the others and the list is not exhaustive. That means that the IRS and the courts have great leeway in their analyses.

Let's take a quick look at the factors:

How the business is run? Is the activity carried on in a businesslike manner?  Do you keep complete and accurate business records and books?  Have you changed business operations to increase profits?

Expertise. Do you have the necessary expertise to run the business? If you don't, do you seek help from experts?

Time and effort. Do you spend the time and effort necessary for the business to succeed?  

Appreciation.  Will business assets appreciate in value over time?  A profit motive can exist if gain from the eventual sale of assets, plus any other income, will result in an overall profit even if there's no profit from current operations.

Success with other activities. Have you engaged in similar activities in the past?

History of income or loss. This factor looks to when the losses occurred. Were they in the start-up phase? Maybe they were due to unforeseen circumstances. Losses over a very long period of time could, but not always, indicate a hobby.

Amounts of occasional profits. Are your occasional profits significant when compared to the size of your investment and prior losses?

Financial status of owner. Is the activity your only source of income?

Personal pleasure or recreation. Is your business of a type that is not usually considered to have elements of personal pleasure or recreation?

Your financial status

If the activity is your only source of income, you would think that the IRS would automatically treat it as a for-profit business. That's not true. Every case is different and the IRS and the courts look at all the circumstances.

A few years ago, there was a case in the U.S. Tax Court involving a married couple. The husband owned a house framing business. His income was about $33,000 a year. The wife worked as a secretary in an accounting department of a big corporation. Her income was about $28,000 a year.

Together, they also operated a horse breeding and racing activity. They had no experience in breeding or racing horses. They didn't have the best of luck either. Several of their horses suffered injuries and they were involved in a legal dispute over the ownership of one. They did seek help from experts and also kept good financial records.

The Tax Court looked at all the nine factors. It recognized that the couple had a very modest income from their employment and this factor weighed in their favor. However, some of the other factors went against them, especially the fact that they never made a profit after 16 years and lost nearly $500,000.  The court knew that the couple "hoped" to make a profit but hope wasn't enough and the court found their business was not engaged in for a profit.

Presumption

Generally, the IRS presumes that an activity is carried on for profit if it makes a profit during at least three of the last five years, including the current year. If it appears that the business will not be profitable for some years, you won't be able to come within the presumption of profit motive. You'll have to rely on qualifying under the nine factors.

The IRS has a form on which you can officially elect to have the agency wait until the first five years are up before examining the profitability of your business.  While it's generally not necessary to file the form in order to take advantage of the presumption, it's usually a good idea.

Types of businesses

Although the IRS is not limited in the kind of businesses that it can challenge as being hobbies, businesses that look like traditional hobbies generally face a greater chance of IRS scrutiny than other types of businesses. These include horse breeding and racing, "gentlemen farming" and craft businesses operated from the home. There are many court cases about these activities and usually the taxpayers lose.

This is a very complicated area of the tax law and many people, like the secretary and her husband, honestly believe they are operating a for-profit business. But as we've seen, the IRS and the courts can, and often do, determine otherwise.

Don't hesitate to contact us if you have any questions about the differences between a business and a hobby ...and how you can set up your operations to have a better chance of falling on the right side of any argument with the IRS.

Only 50 percent of the cost of meals is generally deductible. A meal deduction is customarily allowed when the meal is business related and incurred in one of two instances:

(1) while traveling away from home (a circumstance in which business duties require you to be away from the general area of your tax home for longer than an ordinary day's work); and

(2) while entertaining during which a discussion directly related to business takes place.

Entertainment expenses generally do not meet the "directly related test" when the taxpayer is not present at the activity or event. Both your meal and the meal provided to your business guest(s)' is restricted to 50 percent of the cost.

Related expenses, such as taxes, tips, and parking fees must be included in the total expenses before applying the 50-percent reduction. However, allowable deductions for transportation costs to and from a business meal are not reduced.

The 50-percent deduction limitation also applies to meals and entertainment expenses that are reimbursed under an accountable plan to a taxpayer's employees. It doesn't matter if the taxpayer reimburses the employees for 100 percent of the expenses. "Supper money" paid when an employee works late similarly may be tax free to the employee but only one-half may be deducted by the employer. The same principle applies to meals provided at an employees-only business luncheon, dinner, etc.

A special exception to the 50 percent rule applies to workers who are away from home while working under Department of Transportation regulations. For these workers, meals are 75 percent deductible in 2006 and 2007.

When a per diem allowance is paid for lodging, meal, and incidental expenses, the entire amount of the federal meals and incidental expense (M&IE) rate is treated as an expense for food or beverages subject to the percentage limitation on deducting meal and entertainment expenses. When a per diem allowance for lodging, meal, and incidental expenses for a full day of travel is less than the federal per diem rate for the locality of travel, the payer may treat 40 percent of the per diem allowance as the federal M&IE rate.

"Lavish" meals out of proportion to customary business practice are generally not deductible to the extent they are lavish. Generally, meals taken alone whentraveling generally have a lower threshold for lavishness than meals considered an entertainment expense for which a client or other business contact is "wined and dined."

The AMT is difficult to apply and the exact computation is very complex. If you owed AMT last year and no unusual deduction or windfall had come your way that year, you're sufficiently at risk this year to apply a detailed set of computations to any AMT assessment. Ballpark estimates just won't work.

If you did not owe AMT last year, you still may be at risk. The IRS estimates that half million more individuals will be subject to the AMT in 2006 because of rising deductions and exemptions. If Congress doesn't extend the same AMT exclusion amount given in 2005, an estimated 3 million more taxpayers will pay AMT.

For a system that was intended originally to target only the very rich, the AMT now hits many middle to upper-middle class taxpayers as well. Obviously something has to be done, and will be, eventually, through proposed tax reform measures. In the meantime, expect AMT to be around for at least another year.

Basic calculations. Whether you will be liable for the AMT depends on your combination of income, adjustments and preferences. After all the computations, if your AMT liability exceeds your income tax liability, you will be liable for the AMT. Here are the basic steps to take to determine in evaluating whether you will owe the AMT:

• Step #1: Calculate your regular taxable income. If your regular tax were to be determined by reference to an amount other than taxable income, that amount would need to be determined and used in the next steps.
  
• Step #2: Calculate your alternative minimum taxable income (AMTI) by increasing or reducing your regular taxable income (or other relevant amount) by applying the AMT adjustments or preferences. These include business depreciation adjustments and preferences, loss, timing and personal itemized deductions adjustments, and tax-exempt or excluded income preferences. This is the step with potentially many sub-computations in determining increases and reductions in tax liability.
  
• Step #3:  If your AMTI exceeds the applicable AMT exemption amount, pay AMT on the excess.

While no single factor will automatically trigger the AMT, the cumulative result of several targeted tax benefits considered in Step #2, above, can be fatal. Common items that can cause an "ordinary" taxpayer to be subject to AMT are:

• All personal exemptions (especially of concern to large families);
• Itemized deductions for state and local income taxes and real estate taxes;
• Itemized deductions on home equity loan interest (except on loans used for improvements);
• Miscellaneous Itemized Deductions;
• Accelerated depreciation;
• Income from incentive stock options; and
• Changes in some passive activity loss deductions.

Q: After what period is my federal tax return safe from audit? A: Generally, the time-frame within which the IRS can examine a federal tax return you have filed is three years. To be more specific, Code Sec. 6501 states that the IRS has three years from the later of the deadline for filing the return (usually April 15th for individuals) or, if later, the date you actually filed the return on a requested filing extension or otherwise. This means that if you file your 2014 return on July 10, 2015, the IRS will have until July 10, 2018 to look at it and "assess a deficiency;" not April 15, 2018.

Q: After what period is my federal tax return safe from audit?

A: Generally, the time-frame within which the IRS can examine a federal tax return you have filed is three years. To be more specific, Code Sec. 6501 states that the IRS has three years from the later of the deadline for filing the return (usually April 15th for individuals) or, if later, the date you actually filed the return on a requested filing extension or otherwise. This means that if you file your 2014 return on July 10, 2015, the IRS will have until July 10, 2018 to look at it and "assess a deficiency;" not April 15, 2018.

There are exceptions and caveats to this general principle, however. If you file prior to April 15, the IRS still has until April 15 of the third year that follows to audit your return. This means that if you filed an income tax return on February 10, 2017, you still won't be out-of-the-woods until April 15, 2020. For taxpayers who file fraudulent returns, incorrect returns with the intent to evade tax, and those who do not file at all, the IRS may open an audit at any time.

(Don't confuse the deadline for IRS tax assessments with your right to file a refund claim for an amount that you overpaid, either on a filed return or through withholding or estimated tax payments. That deadline is the later of three years from the filing deadline or two years from your last tax payment.)

You may also find some comfort in the practical IRS audit-cycle rhythm. While you are never truly beyond an audit until the statute of limitations has properly run, there are some general standards to keep in mind. Office audits are usually done within 1 1/2 years of the time the return was filed, and field office audits are complete by 2 1/2 years. The rule of thumb is that if you haven't been contacted within this time frame, you're probably not going to be. Especially for small businesses, the IRS has promised to shorten its normal audit cycle so that those taxpayers are not "left hanging" on potential tax liabilities (with interest and penalties) until the three-year limitations period has expired. Whether this shortened period happens, however, is still open to speculation. Most businesses should continue to make it a practice to keep "tax reserves" to cover such audit liabilities.

One of the easiest ways for a business to limit liability is to use independent contractors instead of employees. Of course, merely calling employees "independent contractors" will not make those individuals independent contractors.

Control

The determination of whether a worker will be considered a contractor or an employee is a question of control. If the worker determines his or her own fees (usually per job), sets his or her own working hours, and provides his or her own tools, he can reasonably be considered an independent contractor. If the worker does not control his or her hours worked or wages, and uses tools provided for him or her by the employer, the worker is probably an employee.

There is a 20-factor common law test that can help determine if a worker is an independent contractor. It is important to work through the factors to determine the correct classification for the worker has been chosen, as the classifications have distinct consequences.

Benefits

The difference between independent contractors and employees is stark, and is not simply limited to the label of the worker.

Independent contractors need not be included in retirement plans. You will only have to pay the contractor gross pay, rather than withholding wages for tax purposes. As you need not pay Social Security, Medicare or unemployment insurance for an independent contractor, record keeping is much simpler.

Independent contractors are also responsible for their own tort and contract liability. If an independent contractor commits a tort, in most cases the contractor will be solely liable.

Proceed with caution

Use extreme caution when labeling workers. Mislabeling workers can lead to serious problems.

You could be responsible for back employment taxes, which are often considerable when interest and penalties attach. You could also be liable for damages in a tort claim decided against the mislabeled worker.

Tort liability for a mislabeled worker can have repercussions beyond the payment of the damages. If the worker is deemed to be an employee, the use of contractors instead of employees for liability limitation is lost, which can impact whether the business was operated in such a manner as to limit liability on the whole.

Using independent contractors can be a smart business move but without careful planning, you could be in for some expensive tax consequences. Give our office a call and we'll take a look at your options.

With all the different tax breaks for taxpayers with children - from the Earned Income Tax Credit (EITC) to the dependent care and child tax credits - you may be wondering who exactly is a "child" for purposes of these incentives. Is there a uniform definition in the Tax Code, or does the definition of a "child" vary according to each tax break?

Generally, a qualifying child for purposes of each tax break requires four tests to be met: relationship, age, residency, and citizenship. This article discusses the definition of "child" for purposes of the EITC, dependent care credit, child tax credit, and dependency exemption.

Child Tax Credit

The child tax credit provides eligible individuals to take an income tax credit of $1,000 for each qualifying child under the age of 17 at the end of the calendar year. The child tax credit is refundable for some taxpayers, but is phased-out for higher-income taxpayers. For purposes of the child tax credit, a qualifying "child" is a child who:

-- Is under the age of 17 at the close of the calendar year;

-- Is your son, daughter, stepson, stepdaughter; foster child; legally adopted child or child placed with your for legal adoption; brother, sister, stepbrother, stepsister, or foster child placed with you by an authorized placement agency or court order; or descendant of any such person;

-- Lives with you for more than half of the tax year; and

-- Is a U.S. citizen, U.S. resident or U.S. national.

Child and Dependent Care Credit

Taxpayers who incur expenses to care for a child under the age of 13 (or for an incapacitated dependent or spouse) in order to work or look for work can claim the child and dependent care credit, which equals 20 percent to 35 percent of employment-related expenses. Both dollar and earned income limits on creditable expenses apply. For purposes of the child and dependent care credit, a qualifying "child" is generally a child who:

-- Is under the age of 13 when the care was provided;

-- Lives with you for more than half of the tax year;

-- Is your son, daughter, stepson, stepdaughter; foster child; legally adopted child or child placed with your for legal adoption; brother, sister, stepbrother, stepsister, or foster child placed with you by an authorized placement agency or court order; or descendant of any such person; and

-- Did not provide more than half of his or her own support for the year.

Earned Income Tax Credit

Eligible lower-income taxpayers with earned income can qualify for the refundable Earned Income Tax Credit (EITC). The credit is phased in as earned income increases, and phased out after earned income exceeds the applicable ceiling. The ceilings and thresholds vary based on the number of the taxpayer's qualifying children. A qualifying "child" for purposes of the EITC is generally a child who:

-- Is under the age of 19, under the age of 24 if a full time-student, at the end of the year;

-- Is your son, daughter, stepson, stepdaughter; foster child; legally adopted child or child placed with your for legal adoption; brother, sister, stepbrother, stepsister, or foster child placed with you by an authorized placement agency or court order; or descendant of any such person; and

-- Lived with you in the U.S. for more than half of the year.

Dependency Exemption

For purposes of the dependency exemption, a qualifying child is generally a child who:

-- Is under the age of 19, or under age 24 if a full-time student, at the end of the year;

-- Is your son, daughter, stepson, stepdaughter; foster child; legally adopted child or child placed with your for legal adoption; brother, sister, stepbrother, stepsister, or foster child placed with you by an authorized placement agency or court order; or descendant of any such person;

-- Lived with you with you for more than half of a year; and

-- Did not provide more than half of his or her own support for the year.

If you have questions about any of these tax breaks, please call our office. We can help determine if you are eligible for these and other tax incentives related to your children.

Just because you're married doesn't mean you have to file a joint return. This is a common misconception along with thinking that "married filing separately" applies to couples who are separated or seeking a divorce. As a married couple, you have two choices: file a joint return or file separate returns. Naturally, there are benefits and detriments to each and your tax advisor can chart the best course of action for you.

Traditional treatment

Historically, the tax laws reward marriage. Married couples are eligible for many incentives. For example, they can make tax-free gifts of up to $26,000 (for 2009) to the same individual ($13,000 from each spouse). Single taxpayers can only make tax-free gifts up to $13,000 to the same person. Married couples also have a larger home sale exclusion: they can exclude up to $500,000 in gain from the sale of their home. Single taxpayers are limited to an exclusion of up to $250,000.

Moreover, single individuals no longer have a leg-up when it comes to the standard deduction because of the "marriage penalty." The standard deduction for married couples is now twice the deduction for single taxpayers. For 2009, the standard deduction for married taxpayers filing jointly is $11,400 (for single taxpayers, the standard deduction for 2009 is $5,700). Married taxpayers filing separately also individually take a standard deduction of $5,700 for 2009.

Important credits and deductions

Credits and deductions significantly lower your tax bill. Unfortunately, some credits and deductions are lost unless you file a joint return. These include:

-- HOPE Scholarship credit (temporarily renamed the American Opportunity Education credit for 2009 and 2010);

-- Lifetime Learning credit;

-- Dependent care credit;

-- Earned Income Tax Credit;

-- Adoption credit; and the

-- Deduction for student loan interest.

If these credits and deductions are valuable to you, and you are married, you'll have to file a joint return.

When to file separately

Two events may make you decide to file a separate return:

--Your personal itemized deductions are very high; or

--You do not want to be legally responsible for your spouse's tax liability.

Let's look at the second one first. When a married couple files a joint return they are both legally liable for any tax owed to the government. This is a hard and fast rule. The moment you sign your name to your joint return, you are just as liable for the tax as your spouse. The IRS can come after both of you or just one for the full amount of the tax liability.

Getting out of joint liability is not easy. If you did not know about errors or false statements on your return, you can petition for relief under the innocent spouse rules. The IRS may excuse you from joint liability but the process takes a long time. If you do not want to be liable for your spouse's taxes, don't sign a joint return.

Sometimes one spouse has a large amount of itemized deductions. This often occurs because of illness. Medical expenses are deductible only to the extent that they exceed 7.5 percent of adjusted gross income. If only one spouse had the majority of the couple's medical expenses, it may be easier to overcome the 7.5 percent threshold when only one spouse's income is reported on the return.

Employee business expenses and casualty losses, such as damage from a natural disaster to property owned by one spouse, also are common triggers for filing separately. If these expenses are high, they may reduce your tax bill if reported on a separate return.

Itemizing

If you decide to file separate returns, you and your spouse must itemize deductions or take the standard deduction. You cannot itemize deductions on your return and your spouse take the standard deduction on his return.

Weighing the pros and cons of filing separately is complex and unique to each couple. Lots of other factors, such as children, Social Security and pension benefits, and residency, can make a difference. Contact this office for help in deciding which filing status will maximize your tax breaks and minimize your tax bill.

Although taxes may take a back seat to the basic issue of whether refinancing saves enough money to be worthwhile, you should be aware of the basic tax rules that come into play. Sometimes, you can immediately deduct some of the costs of refinancing.

With mortgage rates at the lowest level in years, you may be debating whether to refinance your adjustable-rate or higher-interest fixed-rate mortgage to lock in what looks like a real bargain. Although taxes may take a back seat to the basic issue of whether refinancing saves enough money to be worthwhile, you should be aware of the basic tax rules that come into play. Sometimes, you can immediately deduct some of the costs of refinancing.

Boom in refinancing

Escalating home prices in many parts of the country have motivated many homeowners to refinance their existing mortgages. Many people are refinancing to secure cash for home improvements or to pay debts. These are often called "cash-out" refinancings because you receive cash back from the lender based upon the difference between the old and new mortgages.

Example. You have an existing mortgage of $195,000. Your home is valued at $325,000. You refinance and take a new mortgage for $225,000. You receive $30,000 from the lender and use the money to pay for home improvements.

Cash-out refinancings account for more than one-half of all refinancings. Some estimates pegged the value of "cash-out" refinancings at more than $100 billion in 2001.

Original mortgage points

The term "points" is used to describe certain charges paid, or treated as paid, by a borrower to obtain a mortgage. Generally, for individuals who itemize, points paid by a borrower at the time a home is purchased are immediately deductible as interest if they are charged solely for the use or forbearance of the lender's money. Points for this purpose include:

• Loan origination fees;

• Processing fees;

• Maximum loan charges; and

• Premium fees.

Amounts paid for services provided by the lender, however, are not deductible as interest. These services include:

• Appraisal fees;

• Credit investigation charges;

• Recording fees; and

• Inspection fees.

Refinancing points

Unlike points paid on an original mortgage, you cannot immediately deduct points paid for refinancing. However, if refinancing proceeds are used to refinance an existing mortgage and to pay for improvements, the portion of points attributable to the improvements is immediately deductible.

With interest rates so low, many homeowners are refinancing for the second or even third time. If you are refinancing for a second time, you may immediately deduct points paid and not yet deducted from the previously refinanced mortgage.

Example. You refinanced your home mortgage several years ago and used the proceeds to pay off your first mortgage. Your refinancing mortgage (loan #2) was a 30-year fixed-rate loan for $100,000. You paid three points ($3,000) on the refinancing. Because all of the loan proceeds were used to pay off the original mortgage and none were used to buy or substantially improve your home, all of the points on the refinancing loan must be deducted over the loan term. This year, you refinance again (loan #3) when there's a remaining (not-yet-deducted) points balance of $2,400 on loan #2. You can deduct the $2,400 as home mortgage interest on your 2003 return.

Deducting interest

Generally, home mortgage interest is any interest you pay on a loan secured by your home. The loan may be a first mortgage, a second mortgage, a line of credit, or a home equity loan.

The interest deduction for points is determined by dividing the points paid by the number of payments to be made over the life of the loan. Usually, this information is available from lenders. You may deduct points only for those payments made in the tax year.

Example. You paid $2,000 in points. You will make 360 payments on a 30-year mortgage. You may deduct $5.65 per monthly payment, or a total of $66.72, if you make 12 payments in one year.

Refinancing is anything but simple. There may be additional complications if there are several mortgages on your home or if you own a vacation home as well as a principal home. Please contact this office if you are considering refinancing now or in the near future.

Q. My husband and I have a housekeeper come in to clean once a week; and someone watches our children for about 10 hours over the course of each week to free up our time for chores. Are there any tax problems here that we are missing?

Q. My husband and I have a housekeeper come in to clean once a week; and someone watches our children for about 10 hours over the course of each week to free up our time for chores. Are there any tax problems here that we are missing?

A. Cooking, cleaning and childcare: domestic concerns - or tax issues? The answer is both. A few years ago, several would-be Presidential appointees were rejected -- when it was revealed that they had failed to pay payroll taxes for their domestic help. The IRS is aggressively looking for cheaters so it's particularly important that you don't stumble through ignorance in not fulfilling your obligations.

Who is responsible

Employers are responsible for withholding and paying payroll taxes for their employees. These taxes include federal, state and local income tax, social security, workers' comp, and unemployment tax. But which domestic workers are employees? The housekeeper who works in your home five days a week? The nanny who is not only paid by you but who lives in a room in your home? The babysitter who watches your children on Saturday nights?

In general, anyone you hire to do household work is your employee if you control what work is done and how it is done. It doesn't matter if the worker is full- or part-time or paid on an hourly, daily, or weekly basis. The exception is an independent contractor. If the worker provides his or her own tools and controls how the work is done, he or she is probably an independent contractor and not your employee. If you obtain help through an agency, the household worker is usually considered their employee and you have no tax obligations to them.

What it costs

In general, if you paid cash wages of at least $1,300 in 2001 to any household employee, you must withhold and pay social security and Medicare taxes. The tax is 15.3 percent of the wages paid. You are responsible for half and your employee for the other half but you may choose to pay the entire amount. If you pay cash wages of at least $1,000 in any quarter to a household employee, you are responsible for paying federal unemployment tax, usually 0.8 percent of cash wages.

Deciding who is an employee is not easy. Contact us for more guidance.

During uncertain economic times, it's easy to feel pessimism and react hastily amid media reports about growing unemployment rates and stock market downturns. However, such actions can wreak havoc on your long-term personal and financial goals. Taking some time out now to put the uncertain future into perspective can help minimize the impact that many external forces can have on your personal and financial life.

During uncertain economic times, it's easy to feel pessimism and react hastily amid media reports about growing unemployment rates and stock market downturns. However, such actions can wreak havoc on your long-term personal and financial goals. Taking some time out now to put the uncertain future into perspective can help minimize the impact that many external forces can have on your personal and financial life.

Prepare for the unexpected. "Always be prepared" is a good motto to live by in order to position yourself, your family, and/or your business to survive and thrive in uncertain economic times. Getting your personal and financial houses in order can result in a viable fallback plan as well as peace of mind.

• Build an emergency fund. We've all heard the sage financial advice to keep 3-6 months of expenses in cash on hand - and many of us have quickly rejected this advice. How much sense does it make to have tens of thousands of dollars sitting around when there are credit card balances to pay off and children's college funds to contribute to? Well, just ask anyone who has unexpectedly lost their job or been faced with a devastating personal tragedy - cash is king. Make your emergency fund priority number one and if 3-6 months of cash seems unreachable to you, consider getting a home equity loan. Low interest rates coupled with high home values can get you into a home equity loan that will cost you little or nothing to maintain each year - an instant emergency fund. And don't procrastinate here - any kind of loan is tough to qualify for when you are unemployed or buried in debt.
• Keep your networking ties fresh. Keeping in touch with peers in your industry can cushion the blow of a job loss as you utilize this network to discover potential job openings. Since people are so mobile in the workplace these days, it's important that you make the effort to stay connected with those who may someday provide you with valuable leads and/or referrals. Remember, networking is a two-way street -- make sure these peers know that they can come to you for the same type of assistance should their careers hit a road bump.

Revisit your portfolio. Call it returning to the scene of the crime - your perhaps battered portfolio probably needs some attention. Revisiting your investment portfolio periodically to make adjustments to take into consideration current economic factors can help you feel a bit more in control of events outside of your control.

• Diversify, diversify, diversify. Diversification is key. It's worth taking the time to ascertain that your portfolio is properly allocated among many different investment vehicles in order to buffer it from potential market downturns or other uncontrollable financial events.
• Keep things in perspective. The stock market moves in a cycle with historically good times as well as bad. Keep your eye on your long-term goals and make sure that any short-term anxiety you may have doesn't knock your portfolio off track and keep you from maximizing your long-term average return.
• Be proactive, not reactive. Certain events - both major and minor - have the ability to send the financial markets on a white-knuckle roller coaster ride. Knee-jerk reactions to daily events unfortunately add more fuel to the fire and can result in an unstable investing environment. On a smaller scale, this same type of reaction can seriously affect your personal investment portfolio as long-term goals are derailed by short-term reactions. This is not to say you should turn a blind eye to current events - on the contrary, it is important to consider these events and their potential impact on your portfolio. However, any changes to your portfolio should be made in a proactive - not reactive - manner, and should take into consideration historical performance as well as possible future trends.

Relax and breathe. Dealing with uncertainty - whether related to your job, investments, health, etc., is never easy and can cause a certain level of anxiety and stress. However, how a person uses this new energy (positively or negatively) can determine their ability to not only survive through the bad times but to thrive as they open themselves up to new opportunities - to get their financial house in order or to prepare themselves to seek out another more fulfilling or secure job or career.

As illustrated above, preparation and perspective are two very important elements need to survive and thrive in an uncertain economy. If you find you need any assistance, do not hesitate to contact the office for additional guidance.

You have just been notified that your tax return is going to be audited ... what now? While the best defense is always a good offense (translation: take steps to avoid an audit in the first place), in the event the IRS does come knocking on your door, here are some basic guidelines you can follow to increase the chances that you will come out of your audit unscathed.

You have just been notified that your tax return is going to be audited ... what now? While the best defense is always a good offense (translation: take steps to avoid an audit in the first place), in the event the IRS does come knocking on your door, here are some basic guidelines you can follow to increase the chances that you will come out of your audit unscathed.

Relax. It is a normal reaction upon receiving notice of an audit to panic and feel particularly singled out, however, as in most situations, panic can be counterproductive. A better course of action is to contact an experienced professional to get additional guidance as to how best to proceed to prepare for the audit as well as to get reassurance that everything will be fine.

Be professional. In the event that you have any type of communication with the IRS prior to your audit -- written or verbal, it's important that you act in a professional, business-like manner. Verbally abusing the auditor or becoming defensive is not a good way to start off your relationship with him or her.

Organization is very important. Before the audit, take the time to gather all of your documents together and consider how they will be presented. While throwing them all into a box in a haphazard fashion is certainly one way to present your documents to your auditor, this method will also be sure to raise at least one eyebrow ... and encourage him or her to dig deeper.

As you gather your data, you may need to re-create records if no longer available. This may involve calls to charities, medical offices, the DMV, etc., to obtain the written documentation required for verification of deductions claimed. Once you are confident that you have all of the necessary documentation, organize it in a binder, separated by category as shown on your return. This will allow quick and easy access to these records during the actual audit, something that the auditor will appreciate and will give him/her the impression that you are organized and thorough.

Leave the face to face to a professional. Make sure that you retain the services of a tax professional, most likely the person who prepared your return. Having a tax professional appear on your behalf for your audit is beneficial in a number of ways.

• A tax professional is emotionally detached from the return and less likely to become angry or defensive if questioned.
• A tax professional can serve as a "buffer" between you and the IRS -- indicating that he/she will need to get back to the auditor on certain issues, can buy you extra time to prepare for an issue raised you didn't consider.
• A tax professional can keep an auditor on track, making sure all inquiries are relevant to the return areas being audited.

If you disagree, appeal. If you disagree with the outcome of the audit, you still have the right to send your case to the IRS Appeals division for review. Appeals officers are usually more experienced than auditors and are more likely to negotiate with you, if necessary.

As for the "best defense is a good offense" comment? In this case, this old adage applies to how you approach the tax return preparation process throughout the year, year-in and year-out.

• Good recordkeeping is key. Maintaining complete and accurate records throughout the year reduces the chance that you will forget to provide important information to your tax preparer, which can increase your chances of audit. Good recordkeeping will also result in a more relaxed reaction to notification of an audit as most of your upfront audit work will be complete -- this is especially true if you audit pertains to a tax year several years in the past! Tax records should be retained for at least 3 years after the filing date.
• Provide ALL relevant information to your tax preparer. When your tax preparer is fully informed of all tax-related events that occurring during the year, the chances for errors or omissions on your return dramatically decrease.
• Keep a low profile. Error-free, complete tax returns that are filed in a timely manner don't have the tendency to raise any of those infamous "red flags" with the IRS. During the year, if the IRS does send you correspondence, it should be responded to immediately and fully. Don't hesitate to retain professional assistance to help you "fly under the radar".

While the odds of your tax return being audited remain very low, it does happen to even the most diligent taxpayers. If you are contacted about an examination by the IRS, take a deep breath, relax and contact the office as soon as possible for additional assistance and guidance.

When it comes to legal separation or divorce, there are many complex situations to address. A divorcing couple faces many important decisions and issues regarding alimony, child support, and the fair division of property. While most courts and judges will not factor in the impact of taxes on a potential property settlement or cash payments, it is important to realize how the value of assets transferred can be materially affected by the tax implications.

When it comes to legal separation or divorce, there are many complex situations to address. A divorcing couple faces many important decisions and issues regarding alimony, child support, and the fair division of property. While most courts and judges will not factor in the impact of taxes on a potential property settlement or cash payments, it is important to realize how the value of assets transferred can be materially affected by the tax implications.

Dependents

One of the most argued points between separating couples regarding taxes is who gets to claim the children as dependents on their tax return, since joint filing is no longer an option. The reason this part of tax law is so important to divorcing parents is that the federal and state exemptions allowed for dependents offer a significant savings to the custodial parent, and there are also substantial child and educational credits that can be taken. The right to claim a child as a dependent from birth through college can be worth over $30,000 in tax savings.

The law states that one parent must be chosen as the head of the household, and that parent may legally claim the dependents on his or her return.

Example: If a couple was divorced or legally separated by December 31 of the last tax year, the law allows the tax exemptions to go to the parent who had physical custody of the children for the greater part of the year (the custodial parent), and that parent would be considered the head of the household. However, if the separation occurs in the last six months of the year and there hasn't yet been a legal divorce or separation by the year's end, the exemptions will go to the parent that has been providing the most financial support to the children, regardless of which parent had custody.

A non-custodial parent can only claim the dependents if the custodial parent releases the right to the exemptions and credits. This needs to be done legally by signing tax Form 8332, Release of Claim to Exemption. However, even if the non-custodial parent is not claiming the children, he or she still has the right to deduct things like medical expenses.

Child support payments are not deductible or taxable. Merely labeling payments as child support is not enough -- various requirements must be met.

Alimony

Alimony is another controversial area for separated or divorced couples, mostly because the payer of the alimony wants to deduct as much of that expense as possible, while the recipient wants to avoid paying as much tax on that income as he or she can. On a yearly tax return, the recipient of alimony is required to claim that money as taxable income, while the payer can deduct the payment, even if he or she chooses not to itemize.

Because alimony plays such a large part in a divorced couple's taxes, the government has specifically outlined what can and can not be considered as an alimony expense. The government says that an alimony payment is one that is required by a divorce or separation decree, is paid by cash, check or money order, and is not already designated as child support. The payer and recipient must not be filing a joint return, and the spouses can not be living in the same house. And the payment cannot be part of a non-cash property settlement or be designated to keep up the payer's property.

There are also complicated recapture rules that may need to be addressed in certain tax situations. When alimony must be recaptured, the payer must report as income part of what was deducted as alimony within the first two payment years.

Property

Many aspects of property settlements are too numerous and detailed to discuss at length, but separating couples should be aware that, when it comes to property distributions, basis should be considered very carefully when negotiating for specific assets.

Example: Let's say you get the house and the spouse gets the stock. The actual split up and distribution is tax-free. However, let's say the house was bought last year for $300,000 and has $100,000 of equity. The stock was bought 20 years ago, is also worth $100,000, but was bought for $10,000. Selling the house would generate no tax in this case and you would get to keep the full $100,000 equity. Selling the $100,000 of stock will generate about $25,000 to $30,000 of federal and state taxes, leaving the other spouse with a net of $70,000. While there may be no taxes to pay for several years if both parties plan to hold the assets for some time, the above example still illustrates an inequitable division of assets due to non-consideration of the underlying basis of the properties distributed.

Under a recent tax law, a spouse who acquires a partial interest in a house through a divorce settlement can move out and still exempt up to $250,000 of any taxable gain. This still holds true if he or she has not lived in the home for two of the last five years, the book states. It also applies to the spouse staying in the home. However, the divorce decree must clearly state that the home will be sold later and the proceeds will be split.

Complications and tax traps can also occur when a jointly owned business is transferred to one spouse in connection with a divorce. Professional tax assistance at the earliest stages of divorce are recommended in situations where a closely held business interest is involved.

Retirement

When a couple splits up, the courts have the authority to divide a retirement plan (whether it's an account or an accrued benefit) between the spouses. If the retirement money is in an IRA account, the individuals need to draw up a written agreement to transfer the IRA balance from one spouse to the other. However, if one spouse is the trustee of a qualified retirement plan, he or she must comply with a Qualified Domestic Relations Order to divide the accrued benefit. Each spouse will then be taxed on the money they receive from this plan, unless it is transferred directly to an IRA, in which case there will be no withholding or income tax liability until the money is withdrawn.

Extreme caution should be exercised when there are company pension and profit-sharing benefits, Keogh plan benefits, and/or IRAs to split up. Unless done appropriately, the split up of these plans will be taxable to the spouse transferring the plan to the other.

Tax Prepayment and Joint Refunds

When a couple prepays taxes by either withholding wages or paying estimated taxes throughout the year, the withholding will be credited to the spouse who earned the underlying income. In community property states, the withholding will be credited equally when spouses each report half of their income. When a joint refund is issued after a couple has separated or divorced, the couple should consult a tax advisor to determine how the refund should be divided. There is a formula that can be used to determine this amount, but it is wisest to use a qualified individual to make sure it is properly applied.

Legal and Other Expenses

To the dismay of most divorcing couples, the massive legal bills most end up paying are not deductible at tax time because they are considered personal nondeductible expenses. On the other hand, if a part of that bill was allocated to tax advice, to securing alimony, or to the protection of business income, those expenses can be deducted when itemizing. However, their total -- combined with other miscellaneous itemized deductions -- must be greater than 2% of the taxpayer's adjusted gross income to qualify.

Divorce planning and the related tax implications can completely change the character of the divorcing couple's negotiations. As many divorce attorneys are not always aware of these tax implications, it is always a good idea to have a qualified tax professional be involved in the dissolution process and planning from the very early stages. If you are in the process of divorce or are considering divorce or legal separation, please contact the office for a consultation and additional guidance.

Q. I have a professional services firm and am considering hiring my wife to help out with some of the administrative tasks in the office. I don't think we'll have a problem working together but I would like to have more information about the tax aspects of such an arrangement before I make the leap. What are some of the tax advantages of hiring my spouse?

Q. I have a professional services firm and am considering hiring my wife to help out with some of the administrative tasks in the office. I don't think we'll have a problem working together but I would like to have more information about the tax aspects of such an arrangement before I make the leap. What are some of the tax advantages of hiring my spouse?

A. Small business owners have long adhered to the practice of hiring family members to help them run their businesses -- results have ranged from very rewarding to absolutely disastrous. From a purely financial aspect, however, it is very important for you as a business owner to consider the tax advantages and potential pitfalls of hiring -- or continuing to employ -- family members in your small business.

Keeping it all in the family

Pay your family -- not Uncle Sam. Hiring family members can be a way of keeping more of your business income available for you and your family. The business gets a deduction for the wages paid -- as long as the family members are performing actual services in exchange for the compensation that they are receiving. This is true even though the family member will have to include the compensation received in income.

Some of the major tax advantages that often can be achieved through hiring a family member -- in this case, your spouse -- include:

Health insurance deduction. If you are self-employed and hire your spouse as a bona fide employee, your spouse -- as one of your employees -- can be given full health insurance coverage for all family members, including you as the business owner. This will convert the family health insurance premiums into a 100% deductible expense.

Company retirement plan participation. You may be able to deduct contributions made on behalf of your spouse to a company sponsored retirement plan if they are employees. The tax rules involved to put family members into your businesses retirement plan are quite complex, however, and generally require you to give equal treatment to all employees, whether or not related.

Travel expenses. If your spouse is an employee, you may be able to deduct the costs attributable to her or him accompanying you on business travel if both of you perform a legitimate business function while travelling.

IRA contributions. Paying your spouse a salary may enable them to make deductible IRA contributions based on the earned income that they receive, or Roth contributions that will accumulate tax-free for eventual tax-free distribution.

"Reasonable compensation"

In order for a business owner to realize any of the advantages connected with the hiring family members as discussed above, it is imperative for the family member to have engaged in bona fide work that merits the compensation being paid. Because this area has such a high potential for abuse, it's definitely a hot issue with the IRS. If compensation paid to a family member is deemed excessive, payments may be reclassified as gifts or as a means of equalizing payments to shareholders.

As you decide on how much to pay your spouse working in your business, keep in mind the reasonable compensation issue. Consider the going market rate for the work that is being done and pay accordingly. This conservative approach could save you money and headaches in the event of an audit by the IRS.

Hiring your spouse can be a rewarding and cost effective solution for your small business. However, in order to get the maximum benefit from such an arrangement, proper planning should be done. For additional guidance, please feel free to contact the office.

Q. Since our children are grown and now out on their own, my husband and I are considering selling our large home and purchasing a small townhouse. We have owned our home for years and have quite a lot of equity built up. How do we figure out how much our potential capital gain would be? Will we pay more in taxes because we are moving to a less expensive home?

If you are considering selling a home you've owned for years and have a lot of equity in - for example, you would like to move to a smaller place - you will want to figure out how much your potential capital gain will be on the sale. Moreover, perhaps you'd also like to know if you'll pay more taxes because you are moving to a less expensive home.

The homesale exclusion

First, you will not be penalized (in the form of recognizable capital gains) for buying a less expensive home that doesn't require that you reinvest all of your gain. Under Code Sec. 121, $500,000($250,000 for single individuals and married taxpayers filing separately) in gain from the sale of a principal residence is generally excluded from income. Remember, however, that under the Economic Recovery Act of 2008, periods of "nonqualifying use" will reduce the amount of gain you can exclude from income.

Determining basis

In order to determine your potential gain or loss from the sale, you will first need to know the basis of your personal residence. The basis of your personal residence is generally made up of three basic components: original cost, improvements, and certain other basis adjustments

Original cost

How your home was acquired will need to be considered when determining its original cost basis.

Purchase or Construction. If you bought your home, your original cost basis will generally include the purchase price of the property and most settlement or closing costs you paid. If you or someone else constructed your home, your basis in the home would be your basis in the land plus the amount you paid to have the home built, including any settlement and closing costs incurred to acquire the land or secure a loan.

Examples of some of the settlement fees and closing costs that will increase the original cost basis of your home are:

• Attorney's fees,
• Abstract fees,
• Charges for installing utility service,
• Transfer and stamp taxes,
• Title search fees,
• Surveys,
• Owner's title insurance, and
• Unreimbursed amounts the seller owes but you pay, such as back taxes or interest; recording or mortgage fees; charges for improvements or repairs, or selling commissions.

Gift. If you acquired your home as a gift, your basis will be the same as it would be in the hands of the donor at the time it was given to you. However, the basis for loss is the lesser of the donor's adjusted basis or the fair market value on the date you received the gift.

Inheritance. If you inherited your home, your basis is the fair market value on the date of the deceased's death or on the "alternate valuation" date, as indicated on the federal estate tax return filed for the deceased.

Divorce. If your home was transferred to you from your ex-spouse incident to your divorce, your basis is the same as the ex-spouse's adjusted basis just before the transfer took place.

Improvements

If you've been in your home any length of time, you most likely have made some home improvements. These improvements will generally increase your home's basis and therefore decrease any potential gain on the sale of your residence. Before you increase your basis for any home improvements, though, you will need to determine which expenditures can actually be considered improvements versus repairs.

An improvement materially adds to the value of your home, considerably prolongs its useful life, or adapts it to new uses. The cost of any improvements can not be deducted and must be added to the basis of your home. Examples of improvements include putting room additions, putting up a fence, putting in new plumbing or wiring, installing a new roof, and resurfacing your patio.

Repairs, on the other hand, are expenses that are incurred to keep the property in a generally efficient operating condition and do not add value or extend the life of the property. For a personal residence, these costs cannot be added to the basis of the home. Examples of repairs are painting, mending drywall, and fixing a minor plumbing problem.

Other basis adjustments

Additional items that will increase your basis include expenditures for restoring damaged property and assessing local improvements. Some common decreases to your home's basis are:

• Insurance reimbursements for casualty losses.
• Deductible casualty losses that aren't covered by insurance.
• Payments received for easement or right-of-way granted.
• Deferred gain(s) on previous home sales.
• Depreciation claimed after May 6, 1997 if you used your home for business or rental purposes.

Recordkeeping

In order to document your home's basis, it is wise to keep the records that substantiate the basis of your residence such as settlement statements, receipts, canceled checks, and other records for all improvements you made. Good records can make your life a lot easier if the IRS ever questions your gain calculation. You should keep these records for as long as you own the home. Once you sell the home, keep the records until the statute of limitations expires (generally three years after the date on which the return was filed reporting the sale)

If you are considering selling your home, it pays to know in advance what the tax ramifications may be. If you need assistance determining the basis of your personal residence, please contact the office for more guidance.

Business travel expenses are not created equal - some special rules apply to certain types of expenditures. Before you pack your bags for your next business trip, make sure that you have planned ahead to optimize your business travel deductions.

Business travel expenses are not created equal - some special rules apply to certain types of expenditures. Before you pack your bags for your next business trip, make sure that you have planned ahead to optimize your business travel deductions.

The basic rule for the deductibility of business travel is relatively simple--travel expenses incurred while you are away from home in pursuit of a trade or business are deductible so long as they are not lavish or extravagant. Business travel can take many different forms, however--conventions, educational seminars, cruise ship meetings and foreign travel, in addition to the run-of-the-mill business trip--and each has its own special rules which you should know about prior to departure so that optimum use is made of the business travel deduction.

The basic rules

Taxpayers who travel away from their tax home on business may deduct the expenses they incur, including fares, meals, lodging, and incidental expenses, if they are not lavish or extravagant. A business trip is considered travel away from home if you may reasonably need sleep or rest to complete a round trip. Your tax home is generally your principal place of business or your residence if you are temporarily employed away from the area of your residence.

To be deductible, traveling expenses must be incurred in pursuit of an existing trade or business. If the expenses are in connection with acquiring a new business, they are not deductible. Of course, there is no rule that prohibits you from enjoying yourself or from pursuing some recreational activities during your travel, but the primary purpose of the trip must be related to the taxpayer's trade or business.

Travel expenses of your spouse, dependents or other individuals are only deductible if the person accompanying you is an employee of the company, the travel is for a bona fide business purpose, and the expenses are otherwise deductible.

Special rules apply

Because special rules may apply, the following types of business travel may require some additional planning in advance in order to maximize your business travel deduction:

Foreign travel

Foreign travel expenses are subject to special rules that are not applicable if the business trip is within the United States. If your travel overseas takes longer than a week, or if less than 75 percent of the time is spent on business, expenses are allocated between business and leisure activities on a day-to-day basis. Each day is either entirely a business day, or it is considered to be a nonbusiness day. A day counts as entirely for business if your principal activity on that day was in pursuit of your trade or business. Travel days are counted as business days, as are days when events beyond your control prevent the conducting of business. Saturdays, Sunday, legal holidays, and other reasonably necessary stand-by days also count as business days.

Educational travel

Although the Tax Code prohibits deducting expenses for travel as a form of education, a recent Tax Court decision allowed a schoolteacher to deduct her travel and tuition costs for two university courses overseas. The court decided that the reason for taking the courses went beyond mere travel and helped the teacher maintain and improve skills needed in her employment.

Conventions and seminars

If there is a sufficient relationship of the convention to your trade or business, expenses for both self-employed persons and employees to attend a convention in the United States may be deducted. A special rule prohibits the deduction of costs of attending seminars or conventions for investment purposes.

Cruises

Although the IRS does not look favorably on cruise ship conventions, a limited deduction is available (to a maximum of $2,000 annually) if you can satisfy some rigorous reporting requirements, and the cruise ship is of US registry, all ports of call are in the US or its possessions, and the meeting is directly related to your trade or business. Reporting requirements include written statements by both you and the officer of the sponsoring organization, containing information as to the number of hours of each day of the trip devoted to scheduled business activities, and a program of the activities of each day of the meeting.

Foreign conventions

While the rule for stateside conventions (and those in Canada, Mexico, a US possession, or the Trust Territory of the Pacific Islands) merely require that your business be related to the agenda of the convention, you are held to a higher standard for conventions held overseas. You must show that the meeting is directly related to the active conduct of your business and that it is as reasonable to be held overseas as it would have been to hold it in the US.

Stayovers

Sometimes costs can be decreased if you stay over at the out-of-town location on Saturday night, even though business was wrapped up on Friday. This occurs when, due to airline pricing policies, the additional lodging expense is more than offset by lower airfare. When this is the case, the additional meal and lodging expenses will still be deductible.

If you have any questions regarding the deductibility of business travel expenses or the related reporting requirements, please contact the office for more information and guidance.

For homeowners, the exclusion of all or a portion of the gain on the sale of their principal residence is an important tax break.

For homeowners, the exclusion of all or a portion of the gain on the sale of their principal residence is an important tax break. The maximum amount of gain from the sale or exchange of a principal residence that may be excluded from income is generally $250,000 ($500,000 for joint filers).

Unfortunately, the $500,000/$250,000 exclusion has a few traps, including a "loophole" closer that reduces the homesale exclusion for periods of "nonqualifying use." Careful planning, however, can alleviate many of them. Here is a review of the more prominent problems that homeowners may experience with the homesale exclusion and some suggestions on how you might avoid them:

Reduced homesale exclusion. The Housing Assistance Tax Act of 2008 modifies the exclusion of gain from the sale of a principal residence, providing that gain from the sale of principal residence will no longer be excluded from income for periods that the home was not used as a principal residence. For example, if you used the residence as a vacation home prior to using it as a principal residence. These periods are referred to as "nonqualifying use." This income inclusion rule applies to home sales after December 31, 2008 and is based on nonqualified use periods beginning on or after January 1, 2009, under a generous transition rule. A specific formula is used to determine the amount of gain allocated to nonqualifying use periods.

Use and ownership. Moreover, in order to qualify for the $250,000/$500,000 exclusion, your home must be used and owned by you as your principal residence for at least 2 out of the last 5 years of ownership before sale. Moving into a new house early, or delaying the move, may cost you the right to exclude any and all gain on the home sale from tax.

Incapacitated taxpayers. If you become physically or mentally incapable of self-care, the rules provide that you are deemed to use a residence as a principal residence during the time in which you own the residence and reside in a licensed care facility (e.g., a nursing home), as long as at least a one-year period of use (under the regular rules) is already met. Moving in with an adult child, even if professional health care workers are hired, will not lower the use time period to one year since care is not in a "licensed care facility." In addition, some "assisted-living" arrangements may not qualify as well.

Pro-rata sales. Under an exception, a sale of a residence more frequently than once every two years is allowed, with a pro-rata allocation of the $500,000/$250,000 exclusion based on time, if the sale is by reason of a change in place of employment, health, or other unforeseen circumstances to be specified under pending IRS rules. Needless to say, it is very important that you make certain that you take steps to make sure that you qualify for this exception, because no tax break is otherwise allowed. For example, health in this circumstance does not require moving into a licensed care facility, but the extent of the health reason for moving must be substantiated.

Tax basis. Under the old rules, you were advised to keep receipts of any capital improvements made to your house so that the cost basis of your residence, for purposes of determining the amount of gain, may be computed properly. In a rapidly appreciating real estate market, you should continue to keep these receipts. Death or divorce may unexpectedly reduce the $500,000 exclusion of gain for joint returns to the $250,000 level reserved for single filers. Even if the $500,000 level is obtained, if you have held your home for years, you may find that the exclusion may fall short of covering all the gain realized unless receipts for improvements are added to provide for an increased basis when making this computation.

Some gain may be taxed. Even if you move into a new house that costs more than the selling price of the old home, a tax on gain will be due (usually 20%) to the extent the gain exceeds the $500,000/$250,000 exclusion. Under the old rules, no gain would have been due.

Home office deduction. The home office deduction may have a significant impact on your home sale exclusion. The gain on the portion of the home that has been written off for depreciation, utilities and other costs as an office at home may not be excluded upon the sale of the residence. One way around this trap is to cease home office use of the residence sufficiently before the sale to comply with the rule that all gain (except attributable to recaptured home office depreciation) is excluded to the extent the taxpayer has not used a home office for two out of the five years prior to sale.

Vacation homes. As mentioned, in order to qualify for the $250,000/$500,000 exclusion, the home must be used and owned by you or your spouse (in the case of a joint return) as your principal residence for at least 2 out of the last 5 years of ownership before sale. Because of this rule, some vacation homeowners who have seen their resort properties increase in value over the years are moving into these homes when they retire and living in them for the 2 years necessary before selling in order to take full advantage of the gain exclusion. For example, doing this on a vacation home that has increased $200,000 in value over the years can save you $40,000 in capital gains tax. However, keep in mind the reduced homesale exclusion for periods of nonqualifying use.

As you can see, there is more to the sale of residence gain exclusion than meets the eye. Before you make any decisions regarding buying or selling any real property, please consider contacting the office for additional information and guidance.

Q. The recent upturn in home values has left me with quite a bit of equity in my home. I would like to tap into this equity to pay off my credit cards and make some major home improvements. If I get a home equity loan, will the interest I pay be fully deductible on my tax return?

Q. The recent upturn in home values has left me with quite a bit of equity in my home. I would like to tap into this equity to pay off my credit cards and make some major home improvements. If I get a home equity loan, will the interest I pay be fully deductible on my tax return?

A. For most people, all interest paid on a home equity loan would be fully deductible as an itemized deduction on their personal tax returns. However, due to changes made to tax laws governing home mortgage interest deduction in 1987, there are limitations and special circumstances that must be considered when determining how much of your home mortgage interest expense is deductible.

Mortgages secured by your qualified home generally fall under one of three classifications for purposes of determining the home mortgage interest deduction: grandfathered debt, home acquisition debt, and home equity debt. Grandfathered debt is simply home mortgage debt taken out prior to October 14, 1987 (including subsequent refinancing of that debt). The other two types of mortgage debt are discussed below. A "qualified home" is your main or second home and, in addition to a house or condominium, can include any property with sleeping, cooking and toilet facilities (e.g., boat, trailer).

Home Acquisition Debt

Home acquisition debt is a mortgage (including a refinanced loan) taken out after October 13, 1987 that is secured by a qualified home and where the proceeds were used to buy, build, or substantially improve that qualified home. "Substantial improvements" are home improvements that add to the value of your home, prolong the useful life of your home, or adapt your home to new uses.

In general, interest expense on home acquisition debt of up to $1 million ($500,000 if married filing separately) is fully deductible. Keep in mind, though, that to the extent that the mortgage debt exceeds the cost of the home plus any substantial improvements, your mortgage interest will be limited. Mortgage interest expense on this excess debt may be deductible as home equity debt (see below).

Example: You have a home worth $400,000 with a first mortgage of $200,000. If you get a home equity loan of $125,000 to build a new addition to your home, your mortgage interest would be fully deductible.

Home Equity Debt

Home equity debt is debt that is secured by your qualified home and that does not qualify as home acquisition debt. There are generally no limits on the use of the proceeds of this type of loan to retain interest deductibility.

The amount of mortgage debt that can be treated as home equity debt for purposes of the mortgage interest deduction is the smaller of a) $100,000 ($50,000 if married filing separately) or b) the total of each qualified home's fair market value (FMV) reduced by home acquisition debt & debt secured prior to October 14, 1987. Mortgage debt in excess of these limits would be treated as non-deductible personal interest.

Example: You have a home worth $400,000 with a first mortgage of $200,000. If you get a home equity loan of $125,000 to pay off your credit cards (you really like to shop!), your mortgage interest deduction would be limited to the amount paid on only $100,000 of the home equity debt.

In addition to the above limitations, there are other circumstances that, if present, can affect your home equity debt interest expense deduction. Here are a few examples:

As illustrated above, determining your deduction for mortgage interest paid can be more complex than it appears. Before you obtain a home equity loan, please feel free to contact the office for advice on how it may affect your potential home mortgage interest deduction.

As a new business owner, you probably expect to incur many expenses before you even open the doors. What you might not know is how these starting up costs are handled for tax purposes. A little knowledge about how these costs will affect your (or your business') tax return can reduce any unexpected surprises when tax time comes around.

As a new business owner, you probably expect to incur many expenses before you even open the doors. What you might not know is how these starting up costs are handled for tax purposes. A little knowledge about how these costs will affect your (or your business') tax return can reduce any unexpected surprises when tax time comes around.

Starting a new business can be an exciting, although expensive, event that finds you, the small business owner, with a constantly open wallet. In most cases, all costs that you incur on behalf of your new company before you open the doors are capital expenses that increase the basis of your business. However, some of these pre-opening expenditures may be amortizable over a period of time if you choose. Pre-opening expenditures that are eligible for amortization will fall into one of two categories: start-up costs or organizational costs.

Start-up Costs

Start-up costs are certain costs associated with creating an active trade or business, investigating the creation or acquisition of an active trade or business, or purchasing an existing trade or business. If, before your business commences, you incur any cost that would normally be deductible as a business expense during the normal course of business, this would qualify as a start-up cost. Examples of typical start-up costs include attorney's fees, pre-opening advertising, fees paid for consultants, and travel costs. However, deductible interest taxes, and research and development (R&D) expenses are treated differently.

Start-up costs are amortized as a group on the business' tax return (or your own return on Schedule C, if you are a sole proprietor) over a period of no less than 60 months. The amortization period would begin in the month that your business began operations. In order to be able to claim the deduction for amortization related to start-up costs, a statement must be filed with the return for the first tax year you are in business by the due date for that return (plus extensions). However, both early (pre-opening) and late (not more than 6 months) submissions of the statement will be accepted by the IRS.

Organizational Costs

Organizational costs are those costs incurred associated with the organization of a corporation or partnership. If a cost is incurred before the commencement of business that is related to the creation of the entity, is chargeable to a capital account, and could be amortized over the life of the entity (if the entity had a fixed life), it would qualify as an organizational cost. Examples of organizational costs include attorney's fees, state incorporation fees, and accounting fees.

Organizational costs are amortized using the same method as start-up costs (see above), although it is not necessary to use the same amortization period for both. A similar statement must be completed and filed with the company's business tax return for the business' first tax year.

Before you decide which, if any, pre-opening expenditures related to your new business you'd like to treat as start-up or organizational costs, please contact our office for additional guidance.

Limited liability companies (LLCs) remain one of the most popular choice of business forms in the U.S. today. This form of business entity is a hybrid that features the best characteristics of other forms of business entities, making it a good choice for both new and existing businesses and their owners.

Limited liability companies (LLCs) remain one of the most popular choice of business forms in the U.S. today. This form of business entity is a hybrid that features the best characteristics of other forms of business entities, making it a good choice for both new and existing businesses and their owners.

An LLC is a legal entity existing separately from its owners that has certain characteristics of both a corporation (limited liability) and a partnership (pass-through taxation). An LLC is created when articles of organization (or the equivalent under each state rules) are filed with the proper state authority, and all fees are paid. An operating agreement detailing the terms agreed to by the members usually accompanies the articles of organization.

Choosing the LLC as a Business Entity

Choosing the form of business entity for a new company is one of the first decisions that a new business owner will have to make. Here's how LLCs compare to other forms of entities:

C Corporation: Both C corporations and LLCs share the favorable limited liability feature and lack of restrictions on number of shareholders. Unlike LLCs, C corporations are subject to double taxation for federal tax purposes - once at the corporate level and the again at the shareholder level. C corporations do not have the ability to make special allocations amongst the shareholders like LLCs.

S Corporation: Both S corporations and LLCs permit pass-through taxation. However, unlike an S corporation, an LLC is not limited to the number or kind of members it can have, potentially giving it greater access to capital. LLCs are also not restricted to a single class of stock, resulting in greater flexibility in the allocation of gains, losses, deductions and credits. And for estate planning purposes, LLCs are a much more flexible tool than S corporations

Partnership: Partnerships, like LLCs, are "pass-through" entities that avoid double taxation. The greatest difference between a partnership and an LLC is that members of LLCs can participate in management without being subject to personal liability, unlike general partners in a partnership.

Sole Proprietorship: Companies that operate as sole proprietors report their income and expenses on Schedule C of Form 1040. Unlike LLCs, sole proprietors' personal liability is unlimited and ownership is limited to one owner. And while generally all of the earnings of a sole proprietorship are subject to self-employment taxes, some LLC members may avoid self-employment taxes under certain circumstances

Tax Consequences of Conversion to an LLC

In most cases, changing your company's form of business to an LLC will be a tax-free transaction. However, there are a few cases where careful consideration of the tax consequences should be analyzed prior to conversion. Here are some general guidelines regarding the tax effects of converting an existing entity to an LLC:

C Corporation to an LLC: Unfortunately, this transaction most likely will be considered a liquidation of the corporation and the formation of a new LLC for federal tax purposes. This type of conversion can result in major tax consequences for the corporation as well as the shareholders and should be considered very carefully.

S Corporation to an LLC: If the corporation was never a C corporation, or wasn't a C corporation within the last 10 years, in most cases, this conversion should be tax-free at the corporate level. However, the tax consequences of such a conversion may be different for the S corporation's shareholders. Since the S corporation is a flow-through entity, and has only one level of tax at the shareholder level, any gain incurred at the corporate level passes through to the shareholders. If, at the time of conversion, the fair market value of the S corporation's assets exceeds their tax basis, the corporation's shareholders may be liable for individual income taxes. Thus, any gain incurred at the corporate level from the appreciation of assets passes through to the S corporation's shareholders when the S corporation transfers assets to the LLC.

Partnership to LLC: This conversion should be tax-free and the new LLC would be treated as a continuation of the partnership.

Sole proprietorship to an LLC: This conversion is another example of a tax-free conversion to an LLC.

While considering the potential tax consequences of conversion is important, keep in mind how your change in entity will also affect the non-tax elements of your business operations. How will a conversion to an LLC effect existing agreements with suppliers, creditors, and financial institutions?

Taxation of LLCs and "Check-the-Box" Regulations

Before federal "check-the-box" regulations were enacted at the end of 1996, it wasn't easy for LLCs to be classified as a partnership for tax purposes. However, the "check-the-box" regulations eliminated many of the difficulties of obtaining partnership tax treatment for an LLC. Under the check-the-box rules, most LLCs with two or more members would receive partnership status, thus avoiding taxation at the entity level as an "association taxed as a corporation."

If an LLC has more than 2 members, it will automatically be classified as a partnership for federal tax purposes. If the LLC has only one member, it will automatically be classified as a sole proprietor and would report all income and expenses on Form 1040, Schedule C. LLCs wishing to change the automatic classification must file Form 8832, Entity Classification Election.

Keep in mind that state tax laws related to LLCs may differ from federal tax laws and should be addressed when considering the LLC as the form of business entity for your business.

Since the information provided is general in nature and may not apply to your specific circumstances, please contact the office for more information or further clarification.

Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.

Maintaining good financial records is an important part of running a successful business. Not only will good records help you identify strengths and weaknesses in your business' operations, but they will also help out tremendously if the IRS comes knocking on your door.

The IRS requires that business owners keep adequate books and records and that they be available when needed for the administration of any provision of the Internal Revenue Code (i.e., an audit). Here are some basic guidelines:

Copies of tax returns. You must keep records that support each item of income or deduction on a business return until the statute of limitations for that return expires. In general, the statute of limitations is three years after the date on which the return was filed. Because the IRS may go back as far as six years to audit a tax return when a substantial understatement of income is suspected, it may be prudent to keep records for at least six years. In cases of suspected tax fraud or if a return is never filed, the statute of limitations never expires.

Employment taxes. Chances are that if you have employees, you've accumulated a great deal of paperwork over the years. The IRS isn't looking to give you a break either: you are required to keep all employment tax records for at least 4 years after the date the tax becomes due or is paid, whichever is later. These records include payroll tax returns and employee time documentation.

Business assets. Records relating to business assets should be kept until the statute of limitations expires for the year in which you dispose of the asset in a taxable disposition. Original acquisition documentation, (e.g. receipts, escrow statements) should be kept to compute any depreciation, amortization, or depletion deduction, and to later determine your cost basis for computing gain or loss when you sell or otherwise dispose of the asset. If your business has leased property that qualifies as a capital lease, you should retain the underlying lease agreement in case the IRS ever questions the nature of the lease.

For property received in a nontaxable exchange, additional documentation must be kept. With this type of transaction, your cost basis in the new property is the same as the cost basis of the property you disposed of, increased by the money you paid. You must keep the records on the old property, as well as on the new property, until the statute of limitations expires for the year in which you dispose of the new property in a taxable disposition.

Inventories. If your business maintains inventory, your recordkeeping requirements are even more arduous. The use of special inventory valuation methods (e.g. LIFO and UNICAP) may prolong the record retention period. For example, if you use the last-in, first-out (LIFO) method of accounting for inventory, you will need to maintain the records necessary to substantiate all costs since the first year you used LIFO.

Specific Computerized Systems Requirements

If your company has modified, or is considering modifying its computer, recordkeeping and/or imaging systems, it is essential that you take the IRS's recently updated recordkeeping requirements into consideration.

If you use a computerized system, you must be able to produce sufficient legible records to support and verify amounts shown on your business tax return and determine your correct tax liability. To meet this qualification, the machine-sensible records must reconcile with your books and business tax return. These records must provide enough detail to identify the underlying source documents. You must also keep all machine-sensible records and a complete description of the computerized portion of your recordkeeping system.

Some additional advice: when your records are no longer needed for tax purposes, think twice before discarding them; they may still be needed for other nontax purposes. Besides the wealth of information good records provide for business planning purposes, insurance companies and/or creditors may have different record retention requirements than the IRS.

After your tax returns have been filed, several questions arise: What do you do with the stack of paperwork? What should you keep? What should you throw away? Will you ever need any of these documents again? Fortunately, recent tax provisions have made it easier for you to part with some of your tax-related clutter.

After your tax returns have been filed, several questions arise: What do you do with the stack of paperwork? What should you keep? What should you throw away? Will you ever need any of these documents again? Fortunately, recent tax provisions have made it easier for you to part with some of your tax-related clutter.

The IRS Restructuring and Reform Act of 1998 created quite a stir when it shifted the "burden of proof" from the taxpayer to the IRS. Although it would appear that this would translate into less of a headache for taxpayers (from a recordkeeping standpoint at least), it doesn't let us off of the hook entirely. Keeping good records is still the best defense against any future questions that the IRS may bring up. Here are some basic guidelines for you to follow as you sift through your tax and financial records:

Copies of returns. Your returns (and all supporting documentation) should be kept until the expiration of the statute of limitations for that tax year, which in most cases is three years after the date on which the return was filed. It's recommended that you keep your tax records for six years, since in some cases where a substantial understatement of income exists, the IRS may go back as far as six years to audit a tax return. In cases of suspected tax fraud or if you never file a return at all, the statute of limitations never expires.

Personal residence. With tax provisions allowing couples to generally take the first $500,000 of profits from the sale of their home tax-free, some people may think this is a good time to purge all of those escrow documents and improvement records. And for most people it is true that you only need to keep papers that document how much you paid for the house, the cost of any major improvements, and any depreciation taken over the years. But before you light a match to the rest of the heap, you need to consider the possibility of the following scenarios:

• • Your gain is more than $500,000 when you eventually sell your house. It could happen. If you couple past deferred gains from prior home sales with future appreciation and inflation, you could be looking at a substantial gain when you sell your house 15+ years from now. It's also possible that tax laws will change in that time, meaning you'll want every scrap of documentation that will support a larger cost basis in the home sold.
  • You did not use the home as a principal residence for a period. A relatively new income inclusion rule applies to home sales after December 31, 2008. Under the Housing and Economic Recovery Act of 2008, gain from the sale of a principal residence will no longer be excluded from gross income for periods that the home was not used as the principal residence. These periods of time are referred to as "non-qualifying use." The rule applies to sales occurring after December 31, 2008, but is based only on non-qualified use periods beginning on or after January 1, 2009. The amount of gain attributed to periods of non-qualified use is the amount of gain multiplied by a fraction, the numerator of which is the aggregate period of non-qualified use during which the property was owned by the taxpayer and the denominator of which is the period the taxpayer owned the property. Remember, however, that "non-qualified" use does not include any use prior to 2009.

• • You may divorce or become widowed. While realizing more than a $500,000 gain on the sale of a home seems unattainable for most people, the gain exclusion for single people is only $250,000, definitely a more realistic number. While a widow(er) will most likely get some relief due to a step-up in basis upon the death of a spouse, an individual may find themselves with a taxable gain if they receive the house in a property settlement pursuant to a divorce. Here again, sufficient documentation to prove a larger cost basis is desirable.

Individual Retirement Accounts. Roth IRA and education IRAs require varying degrees of recordkeeping:

• • Traditional IRAs. Distributions from traditional IRAs are taxable to the extent that the distributions exceed the holder's cost basis in the IRA. If you have made any nondeductible IRA contributions, then you may have basis in your IRAs. Records of IRA contributions and distributions must be kept until all funds have been withdrawn. Form 8606, Nondeductible IRAs, is used to keep track of the cost basis of your IRAs on an ongoing basis.

• • Roth IRAs. Earnings from Roth IRAs are not taxable except in certain cases where there is a premature distribution prior to reaching age 59 1/2. Therefore, recordkeeping for this type of IRA is the fairly simple. Statements from your IRA trustee may be worth keeping in order to document contributions that were made should you ever need to take a withdrawal before age 59 1/2.
  • Education IRAs. Because the proceeds from this type of an IRA must be used for a particular purpose (qualified tuition expenses), you should keep records of all expenditures made until the account is depleted (prior to the holder's 30th birthday). Any expenditures not deemed by the IRS to be qualified expenses will be taxable to the holder.

Investments. Brokerage firm statements, stock purchase and sales confirmations, and dividend reinvestment statements are examples of documents you should keep to verify the cost basis in your securities. If you have securities that you acquired from an inheritance or a gift, it is important to keep documentation of your cost basis. For gifts, this would include any records that support the cost basis of the securities when they were held by the person who gave you the gift. For inherited securities, you will want a copy of any estate or trust returns that were filed.

Keep in mind that there are also many nontax reasons to keep tax and financial records, such as for insurance, home/personal loan, or financial planning purposes. The decision to keep financial records should be made after all factors, including nontax factors, have been considered.

The decision to start your own business comes with many other important decisions. One of the first tasks you will encounter is choosing the legal form of your new business. There are quite a few choices of legal entities, each with their own advantages and disadvantages that must be taken into consideration along with your own personal tax situation.

The decision to start your own business comes with many other important decisions. One of the first tasks you will encounter is choosing the legal form of your new business. There are quite a few choices of legal entities, each with their own advantages and disadvantages that must be taken into consideration along with your own personal tax situation.

Sole proprietorships. By far the simplest and least expensive business form to set up, a sole proprietorship can be maintained with few formalities. However, this type of entity offers no personal liability protection and doesn't allow you to take advantage of many of the tax benefits that are available to corporate employees. Income and expenses from the business are reported on Schedule C of the owner's individual income tax return. Net income is subject to both social security and income taxes.

Partnerships. Similar to a sole proprietorship, a partnership is owned and operated by more than one person. A partnership can resolve the personal liability issue to a certain extent by operating as a limited partnership, but partners whose liability is limited cannot be involved in actively managing the business. In addition, the passive activity loss rules may apply and can reduce the amount of loss deductible from these partnerships. Partners receive a Schedule K-1 with their share of the partnership's income or loss, which is then reported on the partner's individual income tax return.

S corporations. This type of legal entity is somewhat of a hybrid between a partnership and a C corporation. Owners of an S corporation have the same liability protection that is available from a C corporation but business income and expenses are passed through to the owner's (as with a partnership). Like partners and sole proprietors, however, more-than 2% S corporation shareholders are ineligible for tax-favored fringe benefits. Another disadvantage of S corporations is the limitations on the number and kind of permissible shareholders, which can limit an S corporation's growth potential and access to capital. As with a partnership, shareholders receive a Schedule K-1 with their share of the S corporation's income or loss, which is then reported on the shareholder's individual income tax return.

C corporations. Although they do not have the shareholder restrictions that apply to S corporations, the biggest disadvantage of a C corporation is double taxation. Double taxation means that the profits are subject to income tax at the corporate level, and are also taxed to the shareholders when distributed as dividends. This negative tax effect can be minimized, however, by investing the profits back into the business to support the company's growth. An advantage to this form of operation is that shareholder-employees are entitled to tax-advantaged corporate-type fringe benefits, such as medical coverage, disability insurance, and group-term life.

Limited liability company. A relatively new form of legal entity, a limited liability company can be set up to be taxed as a partnership, avoiding the corporate income tax, while limiting the personal liability of the managing members to their investment in the company. A LLC is not subject to tax at the corporate level. However, some states may impose a fee. Like a partnership, the business income and expenses flow through to the owners for inclusion on their individual returns.

Limited liability partnership. An LLP is similar to an LLC, except that an LLP does not offer all of the liability limitations that are available in an LLC structure. Generally, partners are liable for their own actions; however, individual partners are not completely liable for the actions of other partners.

There are more detailed differences and reasons for your choice of an entity, however, these discussions are beyond the scope of this article. Please contact the office for more information.

Please contact the office for more information on this subject and how it pertains to your specific tax or financial situation.