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Archive for the ‘Income Taxes’ Category

My Loving In-Laws-RITA AND JOE circa 1950

Rita and Joe, My Wonderful In-Laws, On Their Wedding Day, June 23,1950

The excitement, joy and anticipation of getting married can be almost overwhelming.  With the planning that goes into the wedding it is easy to overlook the tax implications of marriage.  Although taxes are probably not high on your summer wedding plan checklist, it is important to be aware of the tax changes that come along with marriage. Here are some basic tips that can help keep those issues under control.

Name Change:

The names and Social Security numbers on your tax return must match your Social Security Administration (SSA) records. If you change your name, it is imperative to report it to the SSA.

Change Income Tax Withholding:

A change in your marital status means you must give your employer a new Form W-4, Employee’s Withholding Allowance Certificate.

If you and your spouse both work, your combined incomes may move you into a higher tax bracket. Use the IRS Withholding Calculator tool at IRS.gov to help you complete a new Form W-4. See Publication 505, Tax Withholding and Estimated Tax, for more information.

To avoid problems and to get specific advice speak with your tax adviser.

Changes In Circumstances:

Marriage can have an impact on insurance. It is important that you report changes in circumstances, such as changes in your income or family size, to your health insurance company (or Health Insurance Marketplace).  You should also notify your insurance company when you move out of the area covered by your current insurance plan.

Address Change:

Let the IRS know if your address changes.

You should also notify the U.S. Postal Service. You can ask them online at USPS.com to forward your mail. You may also report the change at your local post office.

Change In Filing Status:

If you’re married as of December 31, that’s your marital status for the entire year for tax purposes. You and your spouse can choose to file your federal income tax return either jointly or separately each year.

Note: Once married, neither of you can file using single status.

Generally and in most cases, married filing jointly results in a lower amount of taxes due.  However, you may want to figure the tax both ways to find out which status results in the lowest tax.

Filing Status For Same-Sex Couples:

If you are legally married in a state or country that recognizes same-sex marriage, you generally must file as married on your federal tax return. This is true even if you and your spouse later live in a state or country that does not recognize same-sex marriage. See Same-Sex Marriage Tax Guide: 16 Essential Tax Rules and Tips for a more detailed discussion. (more…)

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gift, income tax, estate planning

“Son, I am sick and getting old, so fill out a deed to transfer my house into your name now.”

With the increase of the federal estate tax exemption to $5,340,000 in 2014, most taxpayers are not subject to federal estate taxes.  The focus for many now has shifted to the income tax implications that arise when wealth passes to the next generation.  With no regard to the income tax implications, many times elderly people get the idea that the transfer of real estate to children during their lifetime is a good idea in trying to avoid probate and to make things easier for loved ones. Even uninformed realtors, attorneys and other financial advisers sometime make such a recommendation without knowing the tax impact.  However well-meaning, this uninformed strategy can have disastrous income tax results for the children recipients of such ill-conceived lifetime gifts.

Basis Rules:

It is important to understand the following income tax basis rules for calculating gain or loss:

  • Lifetime Gifts:  Children who receive lifetime gifts take a carryover basis in the property received.  The carryover basis is determined by what the maker of the gift originally paid for the asset plus any improvements made to the property.
  • Bequest At Death:  Beneficiaries who receive assets at the decedent’s death get a step up in basis to the date of death value of such assets received.

Basis Rules:  Illustrating How These Rules Operate

Example:  DIY Dad wants to avoid probate and to transfer during his lifetime his real estate to his son, Sad Son.  DIY Dad bought his house in the 1970s for $17,000 and made improvements during the years of $23,000.  As a result his adjusted basis is $40,000.  The house is now worth $540,000.  To save lawyer fees, DIY Dad asks Sad Son to draft a deed to transfer the property.  Sad Son does so and DIY Dad signs the deed and has it recorded with the recorder of deeds.

  • Since this was a lifetime gift, Sad Son takes a carryover basis for the house of $40,000.  Sad Son sells the house for $540,000 shortly afterwards and has a capital gain of $500,000 which he surprisingly  and shockingly learns from his accountant will cost him $100,000 (20% x $500,000) in federal taxes alone.  His accountant tells him there will also be state income taxes on this gain. Since Sad Son is a Pennsylvania resident, he will pay an extra $15,350 in Pennsylvania income taxes.  Total Taxes: $115,350.
    • Form 709:  Any lifetime gifts of over $14,000 require the filing of a Form 709, United States Gift Tax Return, in the year of the gift.  It should also be noted the IRS now checks recorded deeds.  For more on the IRS policing this area please see IRS Checking Real Estate Transfers For Unreported Gifts.
  • Alternate Universe:  DIY Dad consults with his tax/estate attorney who drafts a will that provides for the transfer of his house at death to Sad Son. Sad Son (who now legally changes his name to Happy) Son, has a basis of $540,000 upon his receipt of the house from the estate.  Happy Son, now sells the house and has zero, yes, zero capital gain (Sale Price $540,000 less basis of $540,000 = 0)!
    • Note: Certain states have inheritance taxes.  For example, in Pennsylvania there would be a 4.5% inheritance tax on the real estate, but this is a smaller cost than the capital gains tax that results from taking a carryover basis via a lifetime gift.
  • Fall Back Solutions:
    • If Sad Son stays in the house long enough to qualify the house as his primary residence and all statutory requirements for exclusion are met, he may then exclude $250,000 of the gain on the sale of the house once he sells the house.  If married and all statutory requirements are satisfied,  Sad Sam may be entitled to a $500,000 exclusion. (more…)

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2013 Year-End Tax Planning Guide For Small Businesses

The arrival of year-end presents special opportunities for most small businesses to take steps in lowering their tax liability. The starting point is to run projections to determine the income and tax bracket for this year and what it may be next year.  Once this is known, decisions can be made as to whether any of the following planning tools should be employed to cut taxes before the tax year closes.

It is also important to know that the recent tax act known as ATRA has extended many tax breaks for 2013.  If any of these tax breaks are available, it would be prudent to take advantage of them before they expire.

Also keep in mind that ATRA increased ordinary income tax rates for individuals from 35% to 39.6% starting in 2013 so owners of flow through entities such as partnerships, limited liability companies (LLCs) and S Corporations need to recognize this and other tax changes and plan accordingly.

The following presents some year-end tax strategies that may prove helpful to small businesses and other businesses:

1. Accelerating or deferring income/deductions as part of a year-end tax strategy

A good part of year-end tax planning involves techniques to accelerate or postpone income or deductions, as your tax situation dictates. The idea is to keep income even from year to year. Having spikes in taxable income in any one tax year puts you in a higher average tax bracket than you would be in if you had evened out the amount of taxable income between the current and later year(s).  (Historical note:  For those of you old enough to remember, there was an income averaging rule built into the tax code.  That provision has long been abolished.)

So every year, businesses can take advantage of a traditional planning technique that involves alternatively deferring income and accelerating deductions. For example, business taxpayers such as pass-through entities (limited liability companies, partnerships, S corporations, sole proprietorships) should consider accelerating business income into the current year and deferring deductions until 2014 (and perhaps beyond) if they expect income to rise next year or in the future.

The strategy of accelerating or deferring income and deductions may apply to a number of transactions affecting your business including but not limited to the following:

  • Selling property
  • Leasing
  • Inventory
  • Compensation and bonus practices
  • Depreciation and expense elections.

Cash Basis Small Businesses

Generally, a cash-basis taxpayer recognizes income when received and takes deductions when paid. Here are some more rules for cash basis taxpayers:

  • Income is generally taxable in the year received, by cash or check or direct deposit. You cannot postpone tax on income by refusing payment until the following year once you have the right to that payment in the current year. (This is the so-called the “constructive receipt” rule.)  Therefore, businesses using the cash basis method of accounting recognize and report income when the business actually or constructively receives cash or something equivalent to cash.
  • However, if you make deferred payments a part of the overall transaction, you may legitimately postpone both the income and the tax into the year or years in which payment occurs. Examples include:
    • Installment sales, on which gain is prorated and taxed based upon the years over which installment payments occur
    • Like-kind exchanges through which no gain occurs except to the extent other non-like-kind property (including cash) may change hands
    • Tax-free corporate reorganizations under Section 368 of the Internal Revenue Code.
  • Deductions, however, are generally not allowed until you pay for the item or service for which you want to take the deduction. Merely accepting the liability to pay for a deductible item does not make it deductible. Therefore, a supply bill does not become deductible in the year that the bill is sent for payment. Rather, it is only considered deductible in the year in which you pay the bill.
  • Determining when you pay your bills for tax purposes also has its nuances. A bill may be paid when cash is tendered; when a credit card is charged; or when a check is put in the mail (even if delivered in due course a few days into a new calendar year).

Cash basis businesses that expect to be in a higher tax bracket in 2014 should shift income into 2013 by accelerating cash collections this year, and deferring the payment of deductible expenses until next year, where possible. In this situation, small businesses should try to collect outstanding accounts receivables before the end of 2013.

Accrual Basis Small Businesses

Basically, for accrual-basis taxpayers, generally the right to receive income, rather than actual receipt, determines the year of inclusion of income.  Accrual method businesses that anticipate being in higher rate brackets next year may want to accelerate shipment of products or provision of services into 2013 so that your business’s right to the income arises this year.

Taking the opposite approach:  If you will be in a lower tax bracket next year, an accrual basis taxpayer would delay delivering services or shipping products.

2. Tax Break For Small Business Expense Election Under Section 179

ATRA extended until the end of 2013 the enhanced Code Sec. 179 small business expense. Small businesses that purchase qualifying property can immediately expense up to $500,000 this year.  This amount is reduced dollar for dollar to the extent of the cost of the qualifying property placed in service during the year exceeds $2 million. If you plan to buy property (even computer software qualifies), consider doing so before year-end to take advantage of the immediate tax write-off.

Warning:  Remember that any asset must meet the “placed in service” requirements as well as being purchased before year-end.

Also included as qualified Code Sec. 179 property (only temporarily though) is “qualified” real property, which includes qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property. However, businesses are limited to an immediate write-off of up to $250,000 of the total cost of these properties.

Note, the Section 179 expense limit goes down to $25,000 and the phaseout threshold kicks in at $200,000 starting in 2014.  Also the qualified leasehold-improvement breaks end at the end of 2013.  If you are planning major asset purchases or property improvements over time, you may want to take advantage of this break before year-end.

Final note:  In addition to new property, Section 179 can be applied to used property.

3. Bonus deprecation

ATRA extended this additional first year depreciation allowance into 2013.  This bonus depreciation allows taxpayers to immediately deduct fifty percent (50%) of the cost of qualifying property purchased and placed in service in 2013. Qualifying property must be purchased and placed into service on or before December 31, 2013.

Qualifying property must be new tangible property (refurbished assets do not qualify) with a recovery period of 20 years or less, such as office furniture, equipment and company vehicles, off the shelf computer software and qualified leasehold improvements.

Note that bonus depreciation is not subject to any asset purchase limit like Section 179 property.

4. Accelerated Depreciation

ATRA has retained through 2013 the tax break that allows a shortened 15 year recovery period for qualified leasehold improvements, restaurant and retail improvement property.  Normally the recovery period for this type of property is 39 years so this is a huge tax break.

5. Increased start-up expense deduction

New businesses can take advantage of the increased deduction for start-up expenditures. This start-up expense deduction limit is $10,000. The phaseout threshold is $60,000. Thus, if you have incurred during 2013 start-up costs to create an active trade or business, or the investigation of the creation or acquisition of an active trade or business, you may benefit from this increased deduction. Entrepreneurs can recover more small business start-up expenses up-front, thereby increasing cash flow and providing other benefits.

6. Repair Regulations

The so-called “repair” regulations include a valuable de minimis rule, which could enable taxpayers to expense otherwise capitalized tangible property. Qualified taxpayers may claim a current deduction for the cost of acquiring items of relatively low-cost property, including materials and supplies, if specific requirements are met.

The IRS with their issuance of final regulations relaxed many of the requirements contained in the earlier temporary regulations.  For example, the final regulations removed the ceiling requirements on deductions and now allows the de minimis rule for businesses that do not generate financial statement (applicable financial statements (AFS)).  This allows many small businesses to take advantage of these tax breaks.

The modified safe harbor allows businesses without an AFS to immediately deduct up to $500 or less (or $5,000 or less for taxpayers with an AFS) for qualified property purchases. For example, a business could deduct hundreds of lap-top computers or scanners costing $500 or less each year.

Bottom Line:  The modified safe harbor may be easier for certain small businesses than the Section 179 deduction and 100% bonus depreciation. Most importantly, the regulations now allow taxpayers that do not prepare financial statements to use de minimis safe harbor.  This provides a great benefit for many small businesses that do not normally generate these statements as part of their regular business operations.

7. Compensation arrangements

Timing of Compensation:

In a regular C corporation, compensation paid to employees reduces the taxable income of such corporation.  Ideally, compensation should be used to eliminate taxable income at the corporate level or at least minimize such income.  It is imperative that the total compensation paid is “reasonable” in light of the services performed and industry norms. For more insights into the reasonable compensation issue please read Reasonable Compensation:A Favorite Issue For IRS Auditors.

Use of Retirement Plans:

Corporate retirement plans such as profit sharing, money purchase pension, and defined benefit plans can generate large tax deductions for the entity.  These plans are quite useful when compensation has already reached the highest level of reasonableness.

Important Points:

  • These corporate retirement plans must be drafted and signed before year-end to get tax deductions for that year.
  • These plans can generate a deduction even though the plan is not funded until after year-end, so long as funded by the due date (or the extended due date) of the corporate or entity return.  This gives the small business owner some after the taxable year-end planning flexibility.
  • For profit sharing, money purchase pension and other defined contribution plans, an employer can contribute up to $51,000 per participant.  For participants age 50 and older this amount can be $56,500 because of the catch-up contribution rules.
  • For defined benefit plans, the plan retirement amount and funding are determined by various actuarial computations.  The maximum future benefit can be $205,000 per year upon retirement.  Depending on the age of a participant this can result in a very large contribution each year and one far in excess of the amounts available under the defined contribution plans discussed immediately above.
  • There are various limits and rules specific to each of these plans and the particular make-up of the employees and their ages bear heavily in the proper choice of plan and the design of any plan chosen.

Additionally, and maybe more importantly, when compensation paid to owners is approaching their own:

additional taxes can be saved by making contributions to such plans instead of paying more compensation to the owner.  This can produce a double benefit:  huge income tax savings  and having money being put into a retirement plan to grow tax-free for the benefit of the small business owner.

Use of 2 ½ Month Bonus Rule:

Particularly relevant to employers at year-end is an annual bonus rule. Bonuses paid within a brief period after the end of the employer’s tax year are deductible in that tax year. Compensation is generally considered paid within a brief period of time if it is paid within two and one-half months of the end of the employer’s tax year.

Compensation and K-1 Distributions

Compensation and shareholder or partner distributions from a business, and drawing the often fine line between the two, can make a significant difference to a business owner’s overall tax liability for the year.  For example, for an S corporation, payment of salaries are subject to social security taxes while K-1 income is not subject to this tax.  The strategy here would be to pay less in salary and have more income reported on the Form K-1.  However, taxpayers can be in trouble here if they get greedy.  The IRS is policing this area to make sure that the salary paid is reasonable.  Therefore,   a reasonable salary must be carefully determined and supportable in a tax audit.

Deferring payments of accrued bonuses

In certain situations, it may be preferable to simply ask that your employer pay your bonus in the following year where you expect that your tax bracket will be lower.

8. Other Tax Planning Strategies and Ideas

Here are a number of other year-end tax planning strategies you may want to consider, depending on your particular tax and business situation:

  • Accelerating installment sale proceeds or electing out of the installment method;
  • Elect slower depreciation methods;
  • Determine if you can write-off any bad debts;
  • Consider changing your accounting method to advance income or defer expenses.  This one needs careful consideration, however, as accounting method changes can have a binding effect on taxpayers for many future years;
  • Determining the difference between ordinary business activities and passive activities before implementing a year-end strategy also makes good sense. Rental income or losses, and other passive activity gains and losses, must be netted separately from business gains and losses. Year-end timing for one does not necessarily help control your bottom-line tax cost on the other;
  • Cost Segregation Study:  For those who have purchased, constructed or rehabilitated a building this year, a cost segregation workup may save taxes.  It identifies property components and related costs that can be depreciated faster than the building itself, generating larger deductions.  For example, breaking out costs for fixtures, security equipment, landscaping and parking lots may generate larger tax deductions.  Be careful to take into account the impact of the alternative minimum tax and to consider states that do not follow the federal tax rules.

Final Thoughts:

The above are not intended as a comprehensive list of year-end tax planning tools for small businesses.  The point here is that each business has its own unique tax and business situation.  A case by case analysis to determine which tax planning tools will minimize taxes is the best course of action for small businesses.

If I have missed something or if there is a strategy you want me to explore or explain more fully, please leave a comment below.  I would be glad to help.

For an analysis of what deferral or acceleration planning at year-end may work best for you and your business, please do not hesitate to contact me.

Disclosure and Disclaimer: As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws. This article has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm’s full disclaimer.

 

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IRS Alert: Charitable Contribution Scam

Typhoon Haiyan Disaster

The Internal Revenue Service has just issued a consumer alert about possible scams taking place in the wake of Typhoon Haiyan.  As most of us know, on Nov. 8, 2013, this typhoon known as Yolanda in the Philippines – made landfall in the central Philippines, bringing strong winds and heavy rains that have resulted in flooding, landslides, and widespread damage and personal devastation.

Following major disasters, it is now increasing common for scam artists to impersonate charities to get money or private information from well-intentioned taxpayers.

Fraudulent Contact:

Such fraudulent schemes may involve contact in many ways including the following:

  • Telephone
  • Social media
  • Email or
  • In-person solicitations.

Tips To Avoid Being Scammed:

To avoid your own personal financial disaster, please follow these recommendations:

  • To help disaster victims, donate only to recognized charities.
  • Be wary of charities with names that are similar to familiar or sound like nationally known organizations.
  1. Some phony charities use names or websites that sound or look like those of respected, legitimate organizations.
  2. The IRS website at IRS.gov has a search feature, Exempt Organizations Select Check, through which people may find legitimate, qualified charities; this will help make sure that the donations to these charities are tax-deductible.
  3. Legitimate charities may also be found on the Federal Emergency Management Agency (FEMA) website at fema.gov.
  • BASIC RULE OF LIFE:  Don’t give out personal financial information — such as Social Security numbers or credit card and bank account numbers and passwords — to anyone soliciting contributions.  Scam artists may use this information to steal your identity and money.
  • Don’t give or send cash. For security and tax record purposes, contribute by check or credit card or another way that provides documentation of the gift.  Please read IRS Slams Taxpayers: Attention to Tax Details Matter to learn why this is so important from a tax perspective.

    • Ultra-Careful Tip #1:  In fact, it is probably better to use your credit card as your card company may protect you against such fraudulent charges.
  • If you plan to claim a deduction for your contribution, see IRS Publication 526, Charitable Contributions, to read about the kinds of organizations that can receive deductible contributions.
    • Ultra-Careful Tip #2: Even in situations where there is no fraud, it is prudent to make sure the organization is a qualified tax-exempt organization under federal law.  You may be unpleasantly surprised to know that many organizations erroneously hold themselves out as tax-qualified.  This can result in some nasty tax consequences if an audit by the IRS determines that the organization was not tax-exempt and disallows your charitable deduction.

Bogus Websites and E-Mails:

Bogus websites may solicit funds for disaster victims. Such fraudulent sites frequently mimic the sites of, or use names similar to, legitimate charities, or claim affiliation with legitimate charities to persuade members of the public to send money or provide personal financial information that can be used to steal identities or financial resources.

Additionally, fraudsters often send e-mail that steers the recipient to bogus websites that seem affiliated with legitimate charitable causes.

Final Thoughts:

This is such a sad commentary about our world.  The old refrain “No good deed goes unpunished” is clearly applicable here.  It seems our best and noblest intentions can and will be used against us.  Vigilance, skepticism and prudence are imperative even when we are trying to do the right thing.

Does this kind of fraud strike a nerve or really make you angry?  Or are we just numb to it all and just pass it off as the way of the world? What are your thoughts?  Be sure to let me know what you think in the Leave a Reply below.

As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm’s full disclaimer.

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NIgerianPhoneScam

“These scams are better scripted than some Hollywood movies.”
419 Nigerian Scam Victim

The IRS just renewed its October, 2013 warning about a pervasive phone scam that continues to target people across the nation, including recent immigrants. The Treasury Inspector General for Tax Administration called it the largest scam of its kind. As of March 20, this tax division reported that it has received reports of over 20,000 contacts related to this scam. It also stated that thousands of victims have paid over $1 million to fraudsters claiming to be from the IRS.

As some of you may recall, on Halloween the IRS announced (IR-2013-84) the newest and scariest phone scam.  Someone has a sick sense of humor out there.

This sophisticated and sinister phone scam targets taxpayers,  especially recent immigrants, throughout the country.

Details of This Phone Scam According to the IRS

In this scam, the thief poses as the IRS and makes an unsolicited call to their target. The caller tells the victim they owe taxes to the IRS. They demand that the victim pay the money immediately with a pre-loaded debit card or wire transfer. If the victim refuses to cooperate, they are then threatened with arrest, deportation or suspension of a business or driver’s license. In many cases, the caller becomes hostile and insulting.  As I said, this is really scary stuff.

“This scam has hit taxpayers in nearly every state in the country.  We want to educate taxpayers so they can help protect themselves.  Rest assured, we do not and will not ask for credit card numbers over the phone, nor request a pre-paid debit card or wire transfer,” says IRS Acting Commissioner Danny Werfel. My advice: If you get such a call, hang up immediately!

“If someone unexpectedly calls claiming to be from the IRS and threatens police arrest, deportation or license revocation if you don’t pay immediately, that is a sign that it really isn’t the IRS calling.”  Be aware that the IRS does not contract taxpayers in this fashion.  In almost all cases, the first IRS contact with taxpayers on a tax issue occurs by mail.

Other characteristics of this scam that may lead you to believe that this is a legitimate phone call and to intimidate you into giving them what they want  include the following:

  • These impostors use fake names and IRS badge numbers.
  • They generally use common names and surnames to identify themselves.
  • These con artists may be able to recite the last four digits of a victim’s Social Security Number.
  • These crooks spoof the IRS toll-free number on caller ID to make it seem that it’s the IRS calling.
  • They sometimes send bogus IRS emails to some victims to support their bogus calls.
  • Victims hear background noise of other calls being conducted to mimic a call site.
  • After threatening victims with jail time or driver’s license revocation, these charlatans hang up and others soon call back pretending to be from the local police or DMV, and the caller ID supports their claim.

As you can see, these guys are good.  Do not under any circumstances give them any information or pay them a thing no matter how threatened you may feel!

How To Protect Yourself

If you get a phone call from someone claiming to be from the IRS, here’s what you should do:

  • If you know you owe taxes or you think you might owe taxes, hang up immediately and call your tax attorney, your accountant or the IRS at 800-829-1040. The IRS employees at that line can help you with a payment issue – if there really is such an issue.  This way you know for sure you are dealing with the IRS.
  • If you know you don’t owe taxes or have no reason to think that you owe any taxes (for example, you’ve never received a bill or the caller made some bogus threats as described above), once again, immediately hang up and then call and report the incident to the Treasury Inspector General for Tax Administration at 800-366-4484.
  • If you’ve been targeted by this scam, you should also contact the Federal Trade Commission and use their “FTC Complaint Assistant” at FTC.gov. Please add “IRS Telephone Scam” to the comments of your complaint.

Other Scams

Taxpayers should be aware that there are other unrelated scams (such as a lottery sweepstakes) and solicitations (such as debt relief) that fraudulently claim to be from the IRS. The 419 Nigerian scam depicted in the picture above resulted in losses to many victims in that country.  No matter how believable or how much you are intimidated, never let your guard down and stay skeptical and vigilant.

Know How The IRS Operates

  • The IRS usually first contacts people by mail – not by phone – about unpaid taxes.
  • The IRS does not initiate contact with taxpayers by email to request personal or financial information. In this case, “snail” mail is a good thing.
  • They do not use any type of electronic communication, such as text messages and social media channels.
  • The IRS also does not ask for PINs, passwords or similar confidential access information for credit card, bank or other financial accounts.
  • The IRS won’t ask for payment using a pre-paid debit card or wire transfer. The IRS also won’t ask for a credit card number over the phone.
  • Recipients should not open any attachments or click on any links contained in any message that seems to be from the IRS. Instead, forward the e-mail to phishing@irs.gov.

 

Bottom Line:

  • Be wary of any unexpected phone or email communication allegedly from the IRS.
  • Don’t fall for phone and phishing email scams that use the IRS as a lure.
  • Thieves often pose as the IRS using a bogus refund or warnings to pay past-due taxes.
  • If someone calls you about taxes, they will tell you whether it is the IRS or some state or local authority.  Get their name and badge number and do not give them any information or money.  Then hang up and call that taxing authority directly to get to the bottom of the situation.

Has anyone been a victim of this scam or other scams or fraud?  Please share your experiences in the Leave A Reply area below.

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As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm’s full disclaimer.

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Supreme_Court

Supreme Court Decision on DOMA Impacts Tax Rules for Same Sex Couples

Federal tax rules for same-sex couples have recently been issued in response to the Supreme Court decision in Windsor, No. 12-307 (U.S. 6/26/13). This landmark case invalidated a key provision of the 1996 Defense of Marriage Act (“DOMA”) and resulted in major changes in the tax landscape for many same-sex partners.

These new tax rules were laid out in I.R. 2013-72  on August 29, 2013 and Revenue Ruling 2013-17 on September 16, 2013 and are effective on that date.  (Note that taxpayers who wish to rely on the terms of this Revenue Ruling for earlier periods may choose to do so, as long as the statute of limitations for the earlier period has not expired. More on this below.)

Although there are still some unresolved issues, the following will lay out many of the basic federal income tax rules for same-sex married couples:

  1. State of Celebration Rule:  Same-sex couples that are legally married in jurisdictions that recognize their marriages are treated as married for federal tax purposes.
    • The rule applies even if this couple is currently living in a jurisdiction that does not recognize same-sex marriage.  The IRS states that this is consistent with its long-standing position (Rev. Rul. 58-66) that for federal tax purposes the IRS will recognize marriages based on the law of the state in where consummated and will disregard later changes in domicile.
    • For example, a same-sex couple validly married in New York will still be treated as married when they move to Pennsylvania.
  2. Married:  Being married is any same-sex marriage legally entered into in one of the 50 states, the District of Columbia, a U.S. territory or a foreign country.
  3. Domestic Partnerships:  Registered domestic partnerships, civil unions or similar formal relationships are not considered legal marriages.
  4. Married For All Purposes Under Federal Law:  Under the ruling, legally married same-sex couples are treated as married for all federal tax purposes, including income and gift and estate taxes.
  5. Federal Income Tax Benefits For Married Same-Sex Couples:  Married same-sex couples can now enjoy the tax benefits associated with  being treated as married for all federal tax provisions, including but not limited to:
    • Filing status
    • Claiming personal and dependency exemptions
    • Taking the standard deduction
    • Employee benefits
    • Contributing to an IRA
    • Claiming the earned income tax credit
    • Claiming the child tax credit.
  6. Married Filing Jointly or Married Filing Separately Only Option After September 16, 2013:  After September 16, 2013, legally married same-sex couples generally must file their 2013 federal income tax return using either the married filing jointly or married filing separately filing status.
  7. Two High Income Family:  In some cases, especially where both spouses are high wage earners this may result in greater taxes than under earlier law.
  8. Civil Unions In Certain States May End Up Paying Less Taxes:  Civil unions or domestic partnerships that can still file singly or as head of household may end up in better tax shape in certain situations.
  9. Prior Year Tax Refund Possibility: Individuals who were in same-sex marriages may, but are not required to, file original or amended returns choosing married filing jointly for federal tax purposes for one or more earlier tax years still open under the statute of limitations.
  10. Statute of Limitations For Refunds:  Generally, the statute of limitations for filing a refund claim is three years from the filing date of the return or two years from the date of the tax payment, whichever is later.
    • As a result, refund claims can still be filed for tax years 2010, 2011 and 2012.
    • Special Situations: For example, agreements with the IRS to keep open the statute of limitations for tax years 2009 and earlier will allow taxpayers to file refund claims for such open years .
    • For how to file an amended return please read Amending Tax Returns with the IRS.
  11. Protective Claim: When the right to a refund is contingent and may not be determined until after the time period for amending returns expires, a taxpayer can file a protective claim for refund. The claim is often based on current litigation (constitutionality); expected changes in tax law; and other changes in legislation or regulations. A protective claim preserves the right to claim a refund until resolution of the matter.
    • Example:  Pennsylvania same-sex couples not considered married under current rules may want to file protective claims for any year where the statute of limitations period is ending.
  12. Fringe Benefits: Employees who purchased same-sex spouse health insurance coverage from their employers or other fringe benefits on an after-tax basis may treat the amounts paid for that coverage as pre-tax and excludable from income.
    • The IRS now provides a mechanism to pursue for filing refund claims under Notice 2013-61.  The notice provides two streamlined administrative procedures for making adjustments or claiming refunds.
  13. IRS Further Guidance: The IRS will be issuing further guidance on cafeteria plans and on how qualified retirement plans and other tax-favored arrangements should treat same-sex spouses for periods before September 16, 2013.
  14. State Taxes: State tax return filing status is still controlled by state law.  If same-sex marriages are not legal in their state then they cannot file as married.  This is the case even though the marriage took place in a state where same-sex marriages are recognized.
  15. Estate Planning:  Review estate plans to take advantage of the federal estate and gift tax breaks now given same-sex marriages. For insights into estate planning please read Estate Planning 2013: Now What? A Must Read for Everyone
  16. Estate Tax Refunds: Additionally, claims for refunds of any estate taxes paid on deceased spouses that are still open under the statute of limitations should also be carefully examined.
    • Taxpayers who wish to file a refund claim for gift or estate taxes should file Form 843, Claim for Refund and Request for Abatement.

These are just some of the tax and financial implications in this area.  Same-sex couples affected by these changes should explore estate planning, retirement planning, employee benefits, and social security implications with their estate planning attorney, accountant and financial adviser team.

Stay tuned because this area will continue to evolve and change.

As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm’s full disclaimer.

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Year End Income Tax Planning

Don’t Wait For A Last Minute Miracle:
Get Busy Now on Year End Tax Planning

As the year-end quickly approaches, there is still time to do some year-end tax planning.  This 2013 tax year will be tough on many taxpayers due to recent tax law changes and the uncertain future of tax reform.  Basically, taxpayers will have to deal with the following recent tax law changes:

  • Higher marginal income tax rates.
  • Higher capital gain tax rates.
  • Restoration of the phase out of itemized deductions and exemptions.
  • The new 3.8 percent Medicare tax on unearned income, including interest, dividends and capital gains. etc.  For more details please read 2013 Sneaky New Tax – Not Too Early to Plan for 3.8 % Medicare Tax on Investment Income.
  • The new 0.9 percent tax on earned income in excess of $200,000 for single taxpayers and $250,000 for married taxpayers filing jointly.
  • Same Sex Couples:  The recent Supreme Court decision in Windsor may result in same-sex couples with dual income paying more income taxes filing jointly than if they were still able to file singly.

As always, it is essential to know the customary year-end planning techniques that can cut income taxes.  It all starts with a tax projection of whether you will be in a higher or lower tax bracket next year. Once your tax brackets for this year and next year are known, there are two basic income tax planning considerations:

  • Should income be accelerated or deferred?
  • Should deductions and credits be accelerated or deferred?

However, life is never that simple.  Tax law uncertainty, always makes for some real guesswork.  As discussed below, when it comes to certain deductions that have tax threshold limitations, bunching of deductions to one year may force the timing into a tax year where the tax bracket is lower than the other tax year in question. But this may be the only way to get a tax break for these deductions.

As a further irritant, year-end tax projections must take into account the maddening alternative minimum tax and the new parallel universe of the 3.8% medicare tax.  Yikes.

For discussion purposes, the following strategies assume that the taxpayer’s income will be higher next year.  Where income will be taxed at a higher tax bracket next year, accelerating income to this year results in less taxes being paid.  At the same time deductions and tax credits deferred into next year will become more valuable as they offset income taxed at a higher marginal bracket.

Accelerating income to the current year and deferring deductions must take into account the impact on cash flow and the time value of money when paying taxes on income a year earlier.  However, due to our current low-interest rate environment, time value of money implications are quite minimal and may not be a significant consideration.

If a taxpayer expects income to decrease next year they should use the opposite approach.

So be sure to remember that the following lays out the basic ideas for income acceleration and deduction/credit deferral where income projects to be taxed at a higher level next year.

Income Acceleration: 

For taxpayers who think that they will be in a higher tax bracket next year, here are some targeted forms of income to consider accelerating into this year.

  • Bonuses: Receive bonuses before January 1 of the following year.  If your employer allows you the choice, this may result in some significant income tax savings to you.
  • Accelerate billing and collections.  If you report income on a cash basis method of accounting, immediately sending out bills to increase collections before the end of the year may result in significant tax savings if you know income will be much higher next year.
  • For Salary and Wages and Earned Income: Take Into Account the New 0.9% wage tax:  High income earners will pay an extra 0.9% in social security taxes on earned income above certain thresholds starting in 2013.  Where earned income is low this year and is going up next year, accelerating earned income into the current year may cut this wage tax on earned income entirely.
  • Redeem U.S. Savings Bonds, Certificates of Deposit or Annuities:  Taking these items into income this year may make sense where income projects to be higher next year. (Be sure there are no penalties or surrender charges involved.)  Also where income this year will be below the new 3.8 percent Medicare tax threshold, accelerating this passive income may completely avoid this Medicare tax.  For more on this read 2013 Sneaky New Tax – Not Too Early to Plan for 3.8 % Medicare Tax on Investment Income.
  • Capital Gains: Selling appreciated assets if you expect capital gains at a higher rate next year:  In such situation it may make sense to sell such assets before the end of the year.  For a complete discussion of this issue please see 2012 Year End Tax Planning: Should Taxpayers Sell in 2012 Before Rates Rise?  

Example:  Mr. Appreciation has low basis stock that has appreciated in value. The rate for capital gains can rise as taxable income increases.  So before selling any securities he needs to run the numbers to see if it makes sense to sell this year or next year or spread such sales between the two years. He also needs to consider in the 3.8 percent surcharge on capital gains and how such decision impacts itemized deduction limitations.

Important Planning Point:  For an older taxpayer or one in ill-health, this strategy may not make income tax sense.  When a person dies their assets get a step up in basis to the date of death value.  As a result, when the estate sells such assets there is no capital gain.  So a sale right before death would trigger a needless capital gain tax.

Planning Note:  The wash sale rules do not apply when selling at a gain, so taxpayers can cash out their gains and then repurchase identical securities immediately afterwards.

  • Complete Roth conversions.  Taking into income the monies in IRA accounts in a year before your tax bracket is due to rise may make for some significant tax savings.
  • Accelerate debt forgiveness income with your lender.  In addition to being taxed at a lower tax bracket this year, acceleration also may make sense because of the possibility that tax law reform may end this tax break.  See Expiring Provisions below.
  • Maximize retirement distributions.  Remember the minimum required distributions (MRDs) are the amounts distributed each year to avoid the draconian 50% MRD penalty.  However, taxpayers with IRAs can choose to take larger distributions this year to have such income taxed at a lower income tax rate than the one projected in future years.
  • Electing out or selling outstanding installment contracts.  Disposing of your installment agreement may bring the deferred income into this year at a lower tax rate than anticipated in future years.  It may be helpful to pay tax on the entire gain from an installment sale this year by electing out of installment sale treatment under Section 453(d) of the Internal Revenue Code, rather than deferring tax on the gain to later years.  Conversely, in certain situations installment sale treatment may be a better option since it allows for spreading of income over multiple years.  So it really depends on the specifics of each taxpayer’s tax situation.
  • Take corporate liquidation distributions this year.  Senior or retiring stockholders contemplating the redemption or sale of their shares of stock in their corporation can save considerable taxes by selling their shares this year if their expected tax bracket will be higher in later years.  Warning:  On the other hand consider carefully the step-up in basis implications for older or infirm taxpayers before considering this tax maneuver.

Deductions and Tax Credit Deferrals:

For taxpayers who think that they will be in a higher tax bracket next year, here are some actions to consider in deferring deductions into next year.  Remember, we are assuming that income will be higher next year, so deductions are more valuable next year.  (Obviously, if income is higher this year, it is better to have deductions accelerated into this year).  In any event, taxpayers must watch out for the impact of the alternative minimum tax.

  • Bunch itemized deductions into the year in which they can exceed the applicable threshold.  For certain expenses such as elective surgery, dental work, eye exams, it would be better to have it done in the year that you are already above the applicable AGI threshold.
  • Where income will be greater next year, taking the standard deduction this year and bunching itemized deductions to next year would yield an optimum tax result.
  • For medical expenses, the adjusted gross income (AGI) limitation rises to 10% in 2013 for those under age 65.  Those over age 65 still have an AGI limitation of 7.5%.  Taxpayers at age 64 this year and 65 next year may want to bunch elective medical procedures into next year to get over the lower threshold next year.
  • Postpone paying certain tax-deductible bills until next year to generate a greater tax benefit.
  • Pay fourth quarter state estimated tax installment on January 15 of next year.
  • Postpone “economic performance” for tax-deductible expenses until next year if you are an accrual basis taxpayer.
  • As mentioned above, watch the AMT. Missing the impact of the AMT can make certain year-end strategies counterproductive. For example, aligning certain income and deductions to cut regular tax liability may not work if the deductions reduce regular income but do not cut alternative minimum taxable income.  It is very easy to have your tax planning backfire by missing the difference between the regular tax and AMT tax rules.
    • Example and Important Warning: Do not prepay state and local income taxes or property taxes if subject to the AMT.  It will generate no income tax savings.
  • Watch net investment interest restrictions.
  • Match passive activity income and losses.
  • Harvest tax losses by selling securities or mutual funds.  Selling shares of stock or mutual funds that have gone down in value can offset capital gains and generate a tax loss of up to $3,000 against other income.
    • Warning: If you want to buy back the same security beware of the so-called “wash sale” rules.  These rules are complex but with proper planning losses can be taken while avoiding the wash loss limitation rules.
  • Purchase machinery and equipment before the end of 2013.  Even if you are in a higher tax bracket next year, it may make sense to take advantage of the generous current Section 179 deductions and 50% bonus depreciation.  These tax breaks may not last past 2013.  Or they may be significantly reduced next year.

Other Strategies:

  • Credit Cards To Claim Deductions:  Expenses charged to credit cards before year-end are deductible this year even though paid next year.  Use credit cards to pay:
    • Business Expenses
    • Medical Expenses
    • Property Taxes
    • Other deductions
  • Increase Withholding:  Many taxpayers pay both estimated taxes and withholding taxes. If you have fallen behind on quarterly estimates, it may be a good idea to increase withholding on your remaining wages to avoid underpayment penalties.
    • Key Tax Planning Point: The IRS treats withheld taxes as if spread out evenly throughout the year. This strategy can cut or even eliminate penalties for the failure to pay timely.
  • Do not invest in mutual funds at year-end:  Many mutual funds pay accumulated dividends and capital gains in November and December.  This will result in a needless tax bill and a rude surprise come tax time for the unknowing investor.

Expiring Provisions:

In the past, Congress has extended many, but not all, expiring provisions to future years.  However, there is a lot of uncertainty now as there is talk of major tax reform and still out of control budget deficits.  Prudence may dictate the possible loss of some of the following tax provisions:

  • Sales Tax Deductions:  This deduction has an uncertain future.  So for those in low or no income tax states or who are contemplating a very large purchase, completion before year-end may be warranted.
  • IRA Distributions To Charity:  This provision also faces an unknown future.  Currently, the tax law allows those age 70 1/2 and older to make required distributions directly to charity.  This allows them to avoid income taxation on such distributions.  Note: They do not also get a charitable deduction for such contribution.
  • Discharge of Principal Residence Debt:  Taxpayers who get discharged from debt on their home can avoid being taxed on this form of income.  Those taxpayers involved in a foreclosure should complete this transaction before year-end in the event this law is eliminated next year.
  • Other Expiring Tax Breaks where the taxpayer may want to consider paying before year-end:
    • Residential Energy Property Tax Credit
    • Qualified Tuition Deduction
    • Contribution of Real Estate for Conservation
    • Teachers Classroom Deduction
    • Qualified Tuition Deduction
    • Van-pooling or Mass Transit Benefits
    • Mortgage Insurance Premiums

Final Thoughts and Warnings:

Remember that these are just some of the major year-end income tax strategies and are not all-encompassing.  Taxpayers must take into account possible tax law changes for next year and last-minute tax laws enacted before year-end.

Most importantly remember that income tax strategies depend on the specific income or expenses of each taxpayer and their overall income, gift and estate tax setting.  This discussion offers some, but not all tax strategies.

The one certainty in this uncertain tax environment is to “run the numbers” to find the best approach for each taxpayer’s particular tax and financial situation.

As always, it is quite beneficial to have tax counsel look at the details of your particular income tax situation to carve out specific tax strategies to cut taxes owed.

I hope this article has been of value to my readers. Please feel free to contact me, ask a question or make comments below.

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IRS Wants to Know: Are You Playing Games with Your Employees?

IRS Wants to Know: Are You Playing Games with Your Employees?

The Treasury Inspector General of For Tax Administration recently issued a report entitled Employers Do Not Always Follow Internal Revenue Service Determination Rulings that indicated the employers just do not get it when it comes to treating workers correctly for tax purposes.  This report sheds more light on non-compliance and will result in more audits of small businesses who have miss-classified workers as independent contractors.  So employers beware!

Employers illegally treating employees as independent contractors can come clean through a program called the Voluntary Classification Settlement Program (VCSP).  To explore in more detail the merits of this VCSP program and how it works, readers should look at Risky Business: Playing Fast and Loose with Worker Classification.  Basically, this program allows employers to voluntarily correct erroneously classified workers from independent contractors to employees in exchange for paying less taxes and penalties than if audited by the IRS.  Recently, the IRS provided some needed clarifications of this standard VCSP program under IRS Announcement 2012-46:

  • An employer can now be eligible for this program even if being audited by the IRS, except for a payroll tax audit.
  • An employer that is part of an affiliated group can not use the VCSP program where an employment tax audit involves one of its group members.
  • An employer that is in court contesting classification of workers from a previous audit by the IRS or Department of Labor is not eligible for the VCSP program.
  • An employer no longer has to agree to extend the limitation period on employment tax assessments as part of the closing agreement.  Under the original VCSP program, employers had to extend the statute of limitation for three years for the three taxable years after the date of the closing agreement.  This is no longer required under the standard VCSP program.

Additional Information and Insights:

For those interested in gaining greater insight into this problem and a lot more, please give a listen to my guest appearance on Money For Lunch.  We discuss not only the VCSP program but also explore the allowable “piercing of the corporate veil” by the IRS to impose individual personal tax liability on shareholders and officers for corporate tax obligations under Section 6672 of the Internal Revenue Code.  We also discuss related criminal tax implications.  So please click on the triangle to hear our discussion:

Money for Lunch

Bottom Line:

Employers should objectively and carefully review their employment policies.  If they are playing fast and loose with their classification of employees it could blow up in their face down the road.  The voluntary payments under this special program could be far less than the cost of an IRS employment tax audit for all open years resulting in the required payment of back taxes, interest and penalties.  With the IRS audit presence in this area, this may end up being a costly and in some cases a fatal gamble for a business and its shareholders or owners.  The sure thing is to use the current or the temporary VCSP to clean up a looming and expensive tax problem.

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How Do I Create An Estate Plan Combining All of These Assets?

How Do I Create An Integrated Estate Plan?

We now know what the federal estate tax laws will be this year and in the future.  Our federal government has stated that these estate tax rules are now permanent after a decade of uncertainty.  (A cynic may say that these federal tax laws are permanent until our federal government says they are not!). Anyway, here are some of the more important federal estate tax law changes made on December 31, 2012 along with some related estate planning strategies:

  • The federal estate and gift tax exemption is now permanently (there is that word again) $5,000,000, with annual inflation adjustments.  These inflation adjustments generate exemptions of $5,120,000 in 2012 and $5,250,000 in 2013.
    • A husband and a wife each have this exemption, so a family can transfer $10,500,000 free of federal estate taxes in 2013. These very generous tax exemptions will allow the opportunity to transfer large amounts of wealth during lifetime or at death free of federal taxes.
    • Planning Point:  Taxpayers who used their full $5,120,000 exemption in 2012 can now make more gifts of $130,000 in 2013.
    • Planning Point:  With inflation adjustments each year, taxpayers can continue to transfer more each year.
    • Important Shift in Focus To State Inheritance Taxes:  Understand that we are only talking about federal estate and gift taxes and that these large exemptions are only applicable at the federal level. With these large federal exemptions, for most people, estate tax planning now will focus more on minimizing state inheritance taxes. For example, Pennsylvania does not follow the federal exemption rules and taxes almost all assets owned by a decedent.  To learn more about Pennsylvania inheritance tax rules see Pennsylvania Inheritance Tax: The Basics.
  • Once assets are above the exemption threshold the estate tax rate is 40%.  This results in a very heavy tax bite and is a real concern for anyone above the threshold.  The following taxpayers may end up above the threshold:
    • A taxpayer or a surviving spouse with assets above the exemption threshold or
    • A family (husband and wife) that has accumulated wealth above the $10,500,000 threshold, or
    • A taxpayer that has made lifetime gifts that have exhausted or substantially depleted their exemption.  See the following Example 1.
  • The tax law changes have once again unified the exemption for lifetime gifts and transfers at death.  So, if you use your exemption during your lifetime it is not available when you die.
    • Example 1:  Generous John, gave away his shares of stock of his business corporation valued at $5,000,000 to his son in 2012.  He uses his $5,000,000 exemption to transfer such shares free of gift tax.
    • Example 1A: Generous John dies in 2013 with other assets of $1,250,000 that make up his taxable estate. In 2013, he has a remaining exemption of $250,000 (2013 exemption of $5,250,000 less the $5,000.000 of his exemption used in 2012). Generous John has a taxable estate of $1,000,000 which results in a $400,000 in federal estate tax liability.
  • Portability is now permanent.  Portability allows for the exemption that was not used by the first spouse to die to be used by the surviving spouse.  In theory, this provision protects those who have failed to plan or for those who have made errors in estate planning.
    • Important Planning Point:  Portability should be looked at as a fallback position where there was no estate planning done.
      • Employing traditional estate planning techniques may prove more advantageous and in some cases is essential in crafting a well conceived estate plan. For example, in most situations the combined use of a unified credit and a marital deduction trust (or the use of a disclaimer trust mechanism) would result in better tax outcome than relying on portability.
      • In second marriages, it is often imperative to use  a certain form of marital deduction called a Qualified Terminable Interest Property (QTIP) trust, to provide for both the surviving spouse and children of a first marriage.
      • Where assets are expected to appreciate in value over time, use of a by-pass or unified credit trust would offer a better result than relying on portability.
    • There are some very important limitations and concerns with using portability, especially in second marriages or where the surviving spouse remarried.  These issues are more fully explored in my article entitled Estate Planning Mistakes: 5 Not So Easy Pieces.
    • Portability Does Not Save the GST Exemption:   The new tax act provides that the Generation-Skipping Transfer (GST) tax exemption also remains at the same level as the gift and estate tax exemption ($5,000,000, adjusted for inflation). The GST tax, which is in addition to the federal estate tax, is imposed on amounts transferred (by gift or at death) to grandchildren or others more than one generation below the decedent.  The important point here is that “portability” does not apply to the generation skipping transfer (GST) tax rules. Where grandchildren and future generations are part of an estate plan, portability will not save the unused GST tax exemption of the first spouse to die.  In such cases, using something called a “dynasty” or GST exempt trust is the better course of action.
      • Caveat:   In situations where there the estate size is large and there are many generations who are going to share the estate, failure to understand and use the more traditional dynasty trust could result in a very expensive and disastrous mistake.
  • Annual Donee Exclusion:  Although not part of the tax law changes, this traditional estate and gift tax planning tool allows for annual tax-free gifts of $14,000 in 2013 (up from $13,000 in 2012 as a result of the annual inflation adjustment).  As a result, taxpayers can now give up to $14,000 to as many people as they wish each year and not use up their unified credit or pay a gift tax.
    • Important Note:  Only gifts that qualify as “present interest” gifts are eligible for the annual donee exclusion.
    • Planning Point:  If you are married, your spouse can join you and, together, you can give up to $28,000 per person per year.
    • Planning Point:  This exclusion is in addition to the $5,250,000 estate tax exclusion and can be combined with such exclusion.  For more insight into how to combine these exclusions as well as the lack of marketability and minority interest discounts please read Gifting Shares of Stock In A Bad Economy.
  • Capital Gains and Basis Implications:  Lifetime Gifts versus Transfers At Death:  Although not an estate tax rule, under the new federal tax rules, capital gains on appreciated assets will now be taxed at a 20% rate for taxpayers with income above certain thresholds.  Capital gains below these thresholds will be taxed at the previous 15% rate.  These rules bear heavily in the estate tax planning context especially where recipients receive lifetime gifts versus gifts received at death.
    • Important Tax Basis Rule:  Taxpayers who receive appreciated property by a lifetime gift take a carryover basis, while beneficiaries who receive assets at the decedent’s death get a step up in basis to the date of death value of such assets received.
    • Tax Disaster for the Uninformed, Do It Yourself Estate Planners:  Many times elderly people transfer real estate to children during their lifetime in trying to avoid probate.  For a recipient of such lifetime gift, a disastrous income tax result awaits the uninformed taxpayer as illustrated by the following Example 2.
    • Example 2:  Sam Senior is very sick and wants to avoid probate.  He transfers by quit-claim deed his real estate to his son, Sad Son.  Sam Senior bought his house in the 1970s for $17,000 and made improvements over time of $23,000.  As a result his adjusted basis is $40,000.  The house is now worth $540,000.
      • Sam Senior transfers the house to Sad Son in 2012.  Sad Son takes a carryover basis for the house of $40,000. Sad Son sells the house for $540,000 shortly afterwards and has a capital gain of $500,000 which he surprisingly and sadly finds out will cost him $100,000 (20% x $500,000) in federal taxes alone.  His accountant tells him there will also be state income taxes on this gain. Since he is a Pennsylvania resident, he will pay an extra $15,350 in Pennsylvania income taxes.
      • Alternate Universe:  Sam Senior consults with his tax/estate attorney who drafts a will that transfers the house to son at death. Sad (who now legally changes his name to Happy), has a basis of $540,000 upon his receipt of the house from the estate.  Happy, now sells the house and has zero, yes, zero capital gain (Sale Price, $540,000 less basis of $540,000 = 0)!
        • Note, state inheritance taxes may be applicable in certain states.  For example, in Pennsylvania there would be a 4.5% inheritance tax on the real estate, but this is a lot smaller cost than the capital gains that results from taking a carryover in basis via a lifetime gift.

Final Thoughts and Recommendations:

Federal Estate Tax Implications: The federal estate tax law changes provide for some very generous federal estate tax breaks.  For those close to or above the federal estate tax threshold, the discussion above has explored some of the many planning opportunities to save federal estate taxes.  Such taxpayers should not rely on portability and should meet with an estates attorney to plan the proper course of action based on their particular family situation, needs and goals.

Shift In Focus To State Inheritance Tax Matters: Taxpayers below the federal estate tax thresholds also must continue to plan but the tax focus needs to shift to minimizing state inheritance taxes.

Create An Estate Plan That Fits Your Particular Family and Financial Situation:  It is most important to recognize that everyone has a unique situation with various assets, family members and ideas on how their family members are to be provided for and who should be in charge once they are gone.  As a result, all taxpayers still need to set up an estate plan for non-tax issues such as making sure their assets go to their loved ones in the way they wish.  They need to choose the proper people to administer their estates and any trusts they create.

Young Families:  In younger families, determining a proper guardian for their children and setting up trusts for the protection of their assets and a distribution scheme for such children is of paramount importance and has little to do with taxes.  An objective and unbiased assessment of how much life insurance is required is often needed.

Second Marriages:  Many with second marriages face unique challenges.  An estate plan needs to be developed and implemented to meet the diverse needs and goals of such blended families.

Special Needs Trust:  Those with disabled children or those receiving government benefits may need special needs trusts.

Do Not Try This On Your Own:  Get an Experienced Estate Attorney:  Having experienced estate counsel explore these issues and offer various strategies is at the heart of estate planning.  Coordinating probate and non-probate assets into an integrated estate plan is often overlooked and little understood.

Attention To Details and Documentation: Finally, make sure that you have an experienced estate attorney that can create an integrated estate plan.  Such attorney should have the skills to draft appropriate wills, trusts, durable powers of attorney, living wills and other related documents tailored to your specific family and financial needs.

Please feel free to post comments or ask questions.

Liking and sharing this blog with others in cyberspace is always welcomed and appreciated.

As always, do not hesitate to contact me if you want further insight or need my advice or legal assistance.

Copyright © 2013 – Steven J. Fromm & Associates, P.C., 1420 Walnut Street, Suite 300, Philadelphia, PA 19102. All rights reserved.

As required by United States Treasury Regulations, you should be aware that this communication is not intended by the sender to be used, and it cannot be used, for the purpose of avoiding penalties under United States federal tax laws.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm’s full disclaimer.

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With less than 30 days left in 2012, there is still time to do some year-end tax planning.  This 2012 tax year is more difficult in that no one knows how the tax laws may change before the end of the year.  With certain tax deductions and credits due to expire at the end of 2012 (sunset provisions) and new higher tax brackets kicking in next year (end of the Bush-era tax cuts), year-end tax planning is harder than ever.

However, income tax planning must go on even in this uncertain tax environment.  As a result, it is essential to know the customary year-end planning techniques that cut income taxes.

It all starts with a tax projection of whether you will be in a higher or lower tax bracket next year. Once your tax brackets for 2012 and 2013 are known, there are two basic income tax considerations:

  • Should income be accelerated or deferred?
  • Should deductions and credits be accelerated or deferred?

Example: For income taxed at a higher tax bracket next year, accelerating such income to 2012 results in less taxes being paid.  At the same time deductions and tax credits deferred into next year will become more valuable as they offset income taxed at a higher bracket.

However, life is never that simple.  Tax law uncertainty, especially this year, makes for some real guesswork.  As discussed below, when it comes to certain deductions that have tax threshold limitations, bunching of deductions to one year may force the timing into a tax year where the tax bracket is lower than the other tax year in question. Year end tax projections must take into account the maddening alternative minimum tax.

In any event, the following lays out the basic ideas for income acceleration and deduction/credit deferral in a rising income tax bracket environment.

Income Acceleration: 

For taxpayers who think that they will be in a higher tax bracket, here are some targeted forms of income to consider accelerating into 2012.

  • Receive bonuses before January 1, 2013.  If your employer allows you the choice, this may create some significant income tax savings.  Also, be aware that certain high income earners will pay an extra 0.9% in social security taxes on earned income above certain thresholds starting in 2013.
  • Sell appreciated assets.  With capital gains being taxed at a higher rate in 2013, it may make sense to sell such assets before the end of the year.  For a complete discussion of this issue please see 2012 Year End Tax Planning: Should Taxpayers Sell in 2012 Before Rates Rise?  Important 

Example:  Mr. Appreciation has low basis stock that has appreciated by $200,000 as of December, 2012.  He thinks he will need to liquidate his positions either this year or next. His $200,000 gain will generate $30,000 in federal taxes in 2012 (15% tax).  If Mr. Appreciation waits until 2013, the tax rate may be 25% (or more due to the 2013 higher capital gain rate and 3.8 percent surcharge and itemized deduction limitations) with a tax of $50,000 in 2013.  As a result,  a sale in 2012 may save $20,000.

Note, however, that for an older taxpayer or one in ill-health, this strategy may not make sense since there would be no capital gains (because of the step up in basis rules) if the assets passed through his or her estate.

Planning Note:  The wash sale rules do not apply when selling at a gain, so taxpayers can cash out their gains and then repurchase the securities immediately afterwards.

  • Redeem U.S. Savings Bonds.  Be aware that starting in 2013, a new 3.8 percent Medicare tax on unearned income, including interest, dividends and capital gains, will take effect.  So cashing in these bonds may make sense in the proper situation. For more on this read 2013 Sneaky New Tax – Not Too Early to Plan for 3.8 % Medicare Tax on Investment Income.
  • Complete Roth conversions.  Taking into income the monies in IRA accounts in a year before your tax bracket is due to rise may make for some significant tax savings.
  • Accelerate debt forgiveness income with your lender.
  • Maximize retirement distributions.  Remember the minimum required distributions (MRDs) are the amounts distributed each year to avoid the draconian 50% MRD penalty.  However, taxpayers with IRAs can choose to take larger distributions this year to have such income taxed at a lower income tax rate than in 2013.
  • Electing out or selling outstanding installment contracts.  Disposing of your installment agreement may bring the deferred income into 2012 at a lower tax rate than anticipated in future years.  It may be helpful to pay tax on the entire gain from an installment sale in 2012 by electing out of installment sale treatment under Section 453(d) of the Internal Revenue Code, rather than deferring tax on the gain to later years.  Conversely, in certain situations installment sale treatment may be a better option since it allows for spreading of income over multiple years which may keep taxpayers below the modified adjusted gross income threshold.
  • Accelerate billing and collections.  If you report income on a cash basis method of accounting, immediately sending out bills to increase collections before the end of the year may result in significant tax savings.
  • Take corporate liquidation distributions in 2012.  Senior or retiring stockholders contemplating the redemption or sale of their shares of stock in their corporation can save considerable taxes by selling their shares in 2012.

Deductions and Tax Credit Deferrals:

  • Bunch itemized deductions into 2013 and take the standard deduction into 2012.  Note, however, the AGI limitation rises to 10% in 2013 from the current 7.5% (except for those over age 65), so this limitation may dictate the opposite strategy in certain taxpayer situations.
  • Postpone paying certain tax-deductible bills until 2013.
  • Pay last state estimated tax installment in 2013.
  • Postpone economic performance until 2013 if you are an accrual basis taxpayer.
  • Watch adjusted gross income (“AGI”)  limitations on deductions/credits.  For certain expenses such as elective surgery, dental work, eye exams, it would be better to have it done in the year that you are already above the applicable  AGI  threshold.  However, it may be better to incur these expenses in 2012 where the applicable AGI limit (7.5%) is lower than the 2013 limit (10 % for those under 65).  It all depends on the particulars of each taxpayer.
  • As mentioned above, watch the AMT. Missing the impact of the AMT can make certain year-end strategies counterproductive. For example, aligning certain income and deductions to cut regular tax liability may in fact increase AMT liability.  It is very easy to have your tax planning backfire by missing the difference between the regular tax and AMT tax rules.

Example: Do not prepay state and local income taxes or property taxes if subject to the AMT.  It will generate no income tax benefit.

  • Watch net investment interest restrictions.
  • Match passive activity income and losses.
  • Purchase machinery and equipment before the end of 2012.  The very generous current Section 179 deductions decline in 2013 to $25,000 and there is no 50% bonus depreciation in 2013.

Final Thoughts and Warnings:

Remember that these are some of the customary year-end income tax strategies and are not all-encompassing.  Taxpayers must take into account slated tax law changes for next year and last-minute tax laws enacted before year-end.  Accelerating tax payments must take into account the impact on cash flow and the present value of money.  This is why it is essential to “run the numbers” to find the best steps to reduce the impact of these new tax laws.

Also keep in mind that recent tax law changes, like the 3.8 medicare tax that applies to 2013, bear heavily on income tax planning.  For more details please read 2013 Sneaky New Tax – Not Too Early to Plan for 3.8 % Medicare Tax on Investment Income.

Most importantly remember that income tax strategies depend on the specific income or expenses of each taxpayer and their overall income, gift and estate tax setting.  This discussion offers some but not all tax strategies.

As always, it is quite beneficial to have tax counsel look at the details of your particular income tax situation to carve out specific tax strategies to cut taxes owed.

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Hurricane_Sandy_Marine_hoists_in_Staten_Island,_N.Y.My last post talked about when we can trash tax and other important records. Well, Hurricane Sandy brought a whole new meaning to the concept of trashing records and a whole lot more.

Experts estimate that Hurricane Sandy has caused $50 billion of damage.  Eqecat Inc., a financial advisory firm out of Oakland, California predicts that insurance will cover $10 to $20 billion of such losses.  Storm victims will be on the hook for the other $30 billion of losses.

A couple of points to keep in mind before talking about the casualty loss tax implications:

  • If your house is damaged from this disaster, contact local building authorities to see if the home is inhabitable,
  • Establish an insurance claim, but don’t settle immediately,
  • Make temporary repairs and take other remedial action to prevent further damage to homes and belongings, and
  • Take photos of the damages.

With so many lives in complete turmoil, many of us on the East coast  crushed by Sandy’s wrath are not thinking of  claiming a casualty loss for tax purposes. However, knowing about how taxpayers can claim tax deductions under casualty loss provisions of the Internal Revenue Code is essential in dealing with insurance companies.  While memories are fresh and evidence is still available, now is the time to develop, document and support such casualty losses.

To aid those affected by this devastation readers should look at my article entitled Casualty Losses For Hurricane Sandy.  This article details  the tax qualification rules for being eligible for casualty losses.  It is a must read for anyone devastated by Sandy.

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Papers, papers and still more papers.  When can I destroy these documents?

There are no hard and fast rules in this area.  The following offers some general guidance to carefully consider when determining any destruction of documents.

Against the urge to purge, remember that maintaining documents and records is often essential if a tax audit by the IRS, state or local taxing authority occurs.  Be aware that it is the burden of the taxpayer to provide sufficient proof and support for any tax position taken on a tax return.  Prematurely disposing of relevant documentation and proof supporting a tax deduction or tax position could have a disastrous tax impact.

Tax rules offer some guidance as to minimum document retention periods. It is imperative to keep records such as receipts, canceled checks, and other documents that support an item of income or a deduction, or a credit appearing on a return until the statute of limitations expires for that return. Here are some of the key statute of limitation rules for federal tax returns:

  • For most returns the statute of limitations is 3 years from the date you filed the return. However, the following are some very important exceptions to this 3 year statute of limitation.
  • There is no period of limitations to assess tax when a return is fraudulent or when no return is filed.
  • If income that you should have reported is not reported, and it is more than 25% of the gross income shown on the return, the time to assess is 6 years from when the return is filed.
  • For filing a claim for credit or refund, the period to make the claim generally is 3 years from the date the original return was filed, or 2 years from the date the tax was paid, whichever is later.
  • For filing a claim for a loss from worthless securities the time to make the claim is 7 years from the date the return was due.
  • If you are an employer, you must keep all of your employment tax records for at least 4 years after the tax becomes due or is paid, whichever is later.

Additionally, it is often imperative to check state and local statute of limitation rules before destroying files and records.

Keep in mind that documents may need to be retained and preserved for legal reasons other than taxation, such as, insurance claims or facilitating the transfer of  assets in the case of deceased family member.  Documents like death certificates, estate tax closing letters should be kept indefinitely.

For more detailed guidance on how long to keep specific documents and other document retention considerations and safeguards, please read my article Record Retention For Individuals .

For more detailed guidelines for record retention rules and other protective housekeeping measures for businesses see Record Retention Guidance For Business: A Conservative and Basic Approach.

A discussion with your tax attorney and tax accountant may be a prudent and conservative course of action before destroying any documents or files.

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Risky Business 1920 Silent Film With Gladys Walton

Risky Business 1920 Silent Film With Gladys Walton

In light of the IRS’s fairly recent Voluntary Worker Classification Settlement Program (VCSP) issued in 2012, employers need to consider the benefits and risks of their current classification of employees as independent contractors. This window of opportunity is only available before the IRS or Department of Labor initiates an examination.

Small companies and businesses of many sizes have classified their workers as independent contractors and not employees to gain the following illegal advantages and savings:

  • Avoid paying payroll taxes including Social Security, Medicare, Unemployment, and Federal tax withholding.
  • Avoid having to pay for medical insurance.
  • Avoid making payments of contributions into employer retirement plans.
  • Obtaining services at a fixed rate, no matter what the time required to complete the assignment.
  • Reducing employee record keeping, clerical and other administrative cost savings.

These tempting advantages have created a tremendous incentive for employers to classify workers as independent contractors when they are truly employees.  The IRS has warned that it is stepping up its policing of this area.  Here are some of the costs and penalties employers face if caught by the IRS:

  • Payroll tax liability, plus significant penalties and interest.
  • Various civil and criminal sanctions brought by the IRS, including fines and imprisonment.
  • Retirement plan disqualification or remediation and penalties.  If these workers were wrongly excluded from coverage under any and all retirement plans, such plans would not meet certain plan qualification tests and could be disqualified.  In the alternative,  the employer would have to go through an IRS plan remediation application and pay various penalties and costs to salvage the plan. For more details on plan remediation see Failing To Update Retirement Plans: Avoid Plan Disqualification & Penalties By Using the VCP Program
  • Personal liability for corporate officers of up to 100% of the amount the employer should have withheld from the employee’s compensation in payroll taxes.  Section 6672 imposes personal liability on officers, shareholders and board of directors as “responsible persons.”  For more details read Personal Liability For Corporate Employment Taxes.
  • Legal fees, the lost time spent litigating this matter and the related out-of-pocket costs of litigation.  In these cases, payments to accountants and other experts are necessary for the attorney to prepare for the case and for such experts to appear in court. Even if the case avoids full-blown litigation, legal fees and out-of-court settlement fees will result.

A battle with the IRS is only part of the employer’s problem.  Additionally, a disgruntled or vengeful worker can make real trouble for the employer by making the following claims against the employer:

  • Medical coverage:  If the employer had medical plans for its other employees, these excluded workers may make claims for lack of coverage.
  • Retirement Benefits:  For all the years in which they were erroneously treated as independent contractors, such workers may demand to have contributions made to the employer’s profit-sharing, 401(k), pension or other retirement plan.  This could be a very large liability if the claim involves multiple employees over multiple years.
  • Other Fringe Benefits: In addition to retirement plans, workers may demand stock options, disability payments, workers’ compensation and any other fringe benefits being offered by the employer to its other employees.
  • Overtime Pay:  These workers would be entitled to overtime pay under the Fair Labor Standards Act if the hours he or she provided to the employer in the past exceeded the standard workweek.
  • Unemployment claims.  For those workers erroneously treated as independent, they may assert a claim to collect unemployment for past employment.
  • Lawsuits:  Lawsuits brought against the worker may trigger legal action against the employer to hold the employer legally responsible.

Where the worker seeks reclassification and complains to the authorities, the IRS or the Department of Labor may then get involved by auditing the employer  on how it classifies all of its independent contractors. A full-blown audit could result in economic disaster or ruin for an employer.

Bottom Line:  Any employer playing fast and loose in this area needs to look at their employment practices very carefully.  For determining whether a worker is truly independent please read my article Employee or Independent Contractor?  Finally, see Employers Playing Tax Games with Workers: IRS Offers Way to Come Clean for the details and qualification requirements for coming within the IRS’s Voluntary Worker Classification Settlement Program (VCSP).

The key here is to get with your tax attorney to review your situation and take advantage of the VCSP before the IRS comes knocking on your door.

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IRS_Slams-Taxpayers_On_Bad_Documentation

IRS Slams Taxpayers On Bad Documentation

Taxpayers found out the hard way that the documentation rules imposed by the IRS better be followed exactly and to the letter.  In Durden, TC Memo, 2012-140, taxpayers claimed a $22,517 charitable contribution for 2007.  The IRS disallowed this deduction and the United States Tax Court agreed.

The taxpayers had canceled checks and a letter dated January 10, 2008 from the church confirming this contribution.  Seems like that would be enough.  Wrong!

The IRS did not accept the church’s acknowledgement because it lacked certain language as required under IRS rules.  For a charitable contribution deduction, Section 170(f)(8) of the Internal Revenue Code requires that a monetary contribution of $250 or more must be substantiated by:

  1. A contemporaneous written acknowledgment,
  2. That indicates the amount paid by the taxpayer, and
  3. Whether the organization provided any goods and services in consideration (or in exchange) for the contribution, and if so, a good faith estimate of the value of such goods and services.

The problem for the taxpayers was that the church failed to include part 3 in their January 10, 2008 letter to the taxpayers.  They then went back to the church and got a second letter dated January 21, 2009 that revised the first letter by containing the required language under part 3 of this test.

But now the problem was that the revised letter was too late so it could not be considered contemporaneous by the IRS.  To be contemporaneous under Section 170(f)(8)(C) of the Internal Revenue Code it must be obtained by the due date of the tax return (here April 15, 2008) plus any extensions or, if earlier, the date the taxpayer files the return.  So now the taxpayers flunked part 1 of the test!

You might think that this is pretty harsh since the taxpayer’s really came close here.  So did the taxpayers.  The taxpayers argued that since they substantially complied they should still get the deduction.  The substantial compliance test has been successfully argued where a taxpayer can show that despite strict compliance they have met the essential statutory purpose of such requirement.  The court pointed out that the essential statutory purpose of the acknowledgement rules are  two-fold:

  1. Assist taxpayers in determining their deduction, and
  2. To aid the IRS in processing returns.

The court determined that without a statement from the church that no goods and services were provided,  neither of these two essential statutory purposes can be met.

This is a pretty harsh result for the taxpayers, especially since it was clearly the church that failed to provide the requisite language.  But the object lessons here are clear.

First, when dealing with charitable contributions you better make sure this language is present, especially in cases where large gifts are involved.

Second, when it comes to taxes attention to details is essential.

Third and finally, complying with the various federal, state and local income taxes is complicated.  Having an attention-to-detail minded tax attorney, or tax accountant is greatly recommended and probably essential.  With the loss of this large charitable deduction and the cost to bring this matter before the United States Tax Court, the Durdens definitely found this out the hard way.

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Now that the summer is in full bloom, parents who have sent or considering sending their children to summer camps may not be aware of the tax implications.  Parents who have placed children in camp while they are working or looking for work may be eligible for various tax breaks such as the dependent care credit  and the deduction for medical expenses in certain special situations.  To get a better grasp of the various tax breaks and the special rules and limitations in this area readers should explore Summer Camp: Tax Treatment.

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