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By Editor, July 7, 2011

The recent storms have made the tax treatment of losses, and recoveries related to such events an important topic.  Special tax treatment is provided for Federally Declared Disaster Areas, including an option to claim the loss deduction on the 2010 (prior year) tax return and exclusion from taxation of Qualified Disaster Relief Payments.

The following counties in Alabama have been determined to be Federally Declared Disaster Areas as a result of the recent storms:

Autauga, Bibb, Blount, Calhoun, Chambers, Cherokee, Chilton, Choctaw, Clarke, Colbert, Coosa, Cullman DeKalb, Elmore, Escambia, Etowah, Fayette, Franklin, Greene, Hale, Jackson, Jefferson, Lamar Lauderdale, Lawrence, Limestone, Madison, Marengo, Marion, Marshall, Monroe,  Morgan, Perry, Pickens, Shelby, St. Clair, Sumter, Talladega, Tallapoosa, Tuscaloosa, Walker, Washington, and Winston.

The IRS provides the following information regarding casualty losses:

Casualty Losses – Definition

A casualty is the damage, destruction, or loss of property resulting from an identifiable event that is sudden, unexpected, or unusual.

• A sudden event is one that is swift, not gradual or progressive.
• An unexpected event is one that is ordinarily unanticipated and unintended.
• An unusual event is one that is not a day-to-day occurrence and that is not typical of the activity in which you were engaged.

Casualty Losses – Disaster Loss

A disaster loss is a casualty loss that occurred in an area determined by the President of the United States to warrant federal disaster assistance. These places are known as “Federally Declared Disaster Areas”.

Casualty Losses – Loss Proof

The following is information needed to support a casualty loss claim:

• The type of casualty (car accident, fire, storm, etc.) and when it occurred.
• That the loss was a direct result of the casualty.
• That you were the owner of the property, or if a lessee, that you were contractually liable for the damage.
• Whether a claim for reimbursement exists for which there is a reasonable expectation of recovery.
• Documentary evidence to support the claimed allowable loss.

Casualty Losses – To Prove a Loss

Records may have to be reconstructed. The information gathered will be used for tax purposes, as well as insurance reimbursement.

Casualty Losses – Claiming Disaster Losses on a Return

• Affected taxpayers in a Federal Disaster Area have the option of claiming disaster-related casualty losses on their federal income tax return either in the tax year the casualty occurred or the immediate preceding tax year.
• Depending on when the disaster occurred, claiming the loss on an original or amended return for last year may get the taxpayer an earlier refund. But, waiting to claim the loss on this year’s return could result in a greater tax saving, depending on other income factors.

Casualty Losses – Pub 547 and Pub 584

• Individuals may deduct personal property losses that are not covered by insurance or other reimbursements, but they must first subtract $100 for each casualty event and then subtract ten percent of their adjusted gross income from their total casualty losses for the year.
• Details on figuring a casualty loss deduction can be found in IRS Publication 547, Casualty, Disasters and Thefts.
• Publication 584, Casualty, Disaster and Theft Loss Workbook is designed to help you figure loss on personal-use property. It contains schedules to help you compute loss on your main home, personal property and your vehicles. However, the schedules are for information purposes only. You must file Form 4684 to report your loss on Form 1040.

Casualty Losses – Determination

To determine the amount of casualty loss to claim for damaged or destroyed property, you must:

• Determine the adjusted basis of the property before the disaster.
• Determine the decrease in Fair Market Value (FMV) of the property as a result of the disaster.
• Then, from the smaller of the adjusted basis or the FMV,
• Subtract any insurance or other reimbursement received.
• All individual losses are subject to:
  • 2% AGI limit if used for business by employee.
  • $100 deductible per event.
  • 10% AGI limit per annum.

Casualty Losses – Federally Declared Disaster Areas

In any federally-declared disaster area:

• No gain is recognized on any insurance proceeds received for “unscheduled” personal property that was part of the contents of a main home.
• Payments for the home and any scheduled property are treated as one payment. Any of this money used to replace any type of replacement property is not a recognized gain.
• Disaster relief payments or assistance do not reduce the casualty loss unless they replace lost or destroyed property.
• Disaster unemployment payments are unemployment income and are taxable.
• Post-disaster grants are generally not included in income. See IRC 139.  However, do not include as casualty losses any amounts covered by the grant payments.
• Taxpayers have the option to claim disaster-related casualty losses for either the year of occurrence or the prior year.  However, the State of Alabama allows a claim for the loss only in the year the loss occurs.
• Taxpayers should put the assigned Disaster Designation in red ink at the top of their tax forms. [For example, “Alabama/ Severe Storms, Tornadoes, Straight-line Winds and Flooding.” ]
• Taxpayers should include in income:
  • Temporary living payments from insurance that are in excess of the actual increase in temporary expenses.
  • The excess goes on line 21 of Form 1040.

Gains on Casualty Losses

If you receive an insurance payment or other reimbursement in excess of the adjusted basis of damaged or destroyed property you will have a gain:

• The gain is the amount received minus the adjusted basis in the property.
• If your main home is destroyed and the insurance proceeds result in a gain:
• You can treat this as a sale of residence subject to the same rules.
• If the home was not used or owned for 2 of the last five years a reduced maximum gain exclusion will apply.
• If located in a Federally Declared Disaster Area, you can postpone any “recognized” gain on your main home if you buy a new home within 4 years of the end of the year the disaster occurred, or
• You can recognize the gain and report it.
• You do not have to recognize gain on destroyed/damaged business property if it is replaced within two years of the end of the tax year in which the gain is realized.
• If received payment in 2011 resulting in a gain, you must replace the property prior to 1/1/2014 to defer the gain. 
• You cannot postpone the gain if you buy replacement property from a related party. This applies to:
  • C Corps
  • Partnerships in which more than 50% of the capital or profits is owned by a C Corp
  • All others if the total realized gain for the year is over $100,000.
• To defer the gain:
  • You must buy property specifically to replace the damaged or destroyed property in order to defer the gain.
  • The basis of the replacement property will be the adjusted basis of the property being replaced.

Reporting Casualty Gains/Losses

Report loss on return for year it occurred. If the event took place in a federally declared disaster, you can amend the prior year return.

The election to amend must be made by:

• Due date (without extensions) for filling your income tax return for the tax year in which the disaster actually occurred.
• Due date (with extensions) for filing the return for the preceding tax year.
• Once the election is made, it can be revoked within 90 days of making the election. The taxpayer must:
  • Return any refund or credit received from making the choice.
  • If revoked prior to getting a refund, must return refund within 30 days of receiving it for the revocation to be effective. 

Individual Returns:

• Losses go on Form 4684 and carry to Schedule A.
• Gains go on Form 4684 and carry to Schedule D.
• Includes losses on income-producing property and property used in performing services as an employee (held less than one year).
• Have the option to claim disaster-related casualty losses for either the year of occurrence or the prior year.

Business and income producing property:

• Losses are reported on Form 4684 and carry to various forms.
• Business use of home carries to Form 8829
• .Other business property carries to Form 4797.

Rental Properties:

• Report on Form 4684 and then on Form 4797.
• Have 2 years from the close of tax year when you realize the gain to replace the property and defer the gain.
• Losses are not limited by Form 8582.

Insurance Reimbursement after filing:

• If less than expected (and accounted for on casualty loss) include the difference as a loss on the return for the year when you can reasonably say you’re not getting any more money.
• If greater than expected (and accounted for on casualty loss) include the difference as income in the year received.

Reporting Casualty Gains/Losses –Net Operating Losses

• Individual or Business casualty losses can generate Net Operating Losses (NOL).
• NOLs generated by casualty losses can be carried back or forward the same as any other NOL.

Reporting Casualty Gains/Losses -What’s Not Included

Losses do not include:

• A reduction in profits or
• Loss of income.

The recent storms have been traumatic for many.  There is some tax relief to assist with recovery from these disasters.  Please contact us and we will help you take full advantage of the available tax relief.

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By Editor, June 5, 2011

Although business is business and pleasure is pleasure, the world rarely adheres to absolutes. Thus, this time of year you may want to mix some vacation days with your business travel. With a little planning, you can get Uncle Sam to subsidize your downtime. Here are the strategies for doing just that.

Combine Business and Vacation Plans for Domestic Travel

If you go on a business trip within the U.S. and add on some vacation days, you know you can deduct some of your expenses. The only question is how much. First, let’s cover just the pure transportation expenses. By this, we mean the costs of getting to and from the scene of your business activity, which includes travel to and from your departure airport, the airfare itself, baggage fees and tips, cabs to and from the destination airport, and so forth. Costs for rail travel or to drive your personal car also fits into this category. The bottom line is your domestic transportation costs are 100% deductible, as long as the primary reason for the trip is business rather than pleasure. On the other hand, if vacation is the primary reason for your travel, none of your transportation expenses are deductible.

The IRS doesn’t specify how to determine if the primary reason for domestic travel is business. Obviously, the number of days spent on business versus pleasure is the key factor. We can look to the rules covering foreign travel for guidance on this issue. They say your travel days count as business days, as do weekends and holidays if they fall between days devoted to business, and it would be impractical to return home. “Standby days,” when your physical presence is required, also count as business days, even if you’re not called upon to work on those days. Any other day principally devoted to business activities during normal business hours is also counted as a business day, and so are days when you intended to work, but couldn’t due to reasons beyond your control (local transportation difficulties, power failure, etc.).

For domestic trips, you should be able to claim business was the primary reason for a sojourn whenever the business days exceed the personal days. Be sure to accumulate proof about this and keep the proof with your tax records. For example, if your trip is made to attend client meetings, log everything on your daily planner and copy the pages for your tax file. If you attend a convention or training seminar, keep the program and take some notes to show you attended the sessions.

Once at the destination, your out-of-pocket expenses for business days are fully deductible. Out-of-pocket expenses include lodging, hotel tips, meals (subject to the 50% disallowance rule), seminar and convention fees, and cab fare. Expenses for personal days are nondeductible (except in the “Saturday Night Stayover” situation explained later in this letter).

Example: You are a sole proprietor. You arrange a business meeting with an important client in San Francisco on Wednesday morning. You fly out Sunday evening and spend all day Monday sight-seeing. Tuesday you spend most of the day preparing for the meeting, attend the meeting the next morning, take the client to lunch, and return home Wednesday night. So, Sunday, Tuesday, and Wednesday count as business days. The business meeting obviously necessitated the trip, and you clearly didn’t spend an unreasonable amount of time on personal activities. Therefore, you can deduct your airline tickets, plus your lodging for Sunday and Tuesday nights, 50% of your meals for Sunday, Tuesday, and Wednesday, your other out-of-pocket expenses for those days, and 50% of the cost of lunching with your client.

Maximizing the Tax Benefits of a Saturday Night Stayover

A great way to maximize deductions for the personal portions of a trip is with a Saturday night stayover that reduces the overall cost of the trip. If you can show staying the extra day or two costs less (or no more) than coming back home immediately after the business meeting is over, the IRS allows you to deduct your additional meal and lodging expenses (subject to the 50% disallowance rule for meals) for the extra day(s). Naturally, you still must have a dominant business purpose for making the trip in the first place. Be sure to document that your airfare savings equaled or exceeded the out-of-pocket costs of staying the extra day(s). Keep the proof with your tax records.

Example: You have a business meeting in New York on Monday morning. You and your spouse fly into town Saturday morning and spend the weekend sightseeing. Your round trip airfare is only $400 versus $1,200 if you came in Sunday night and left Monday. In this situation, Saturday is a personal day since you would normally fly in Sunday. No problem. As long as your meal and lodging expenses for Saturday are no more than $800, you can write-off your whole trip (subject to the 50% disallowance rule for meals). Of course, you generally can’t deduct the additional costs for your spouse (his or her airfare and meals and any extra charges for having two people instead of one in the hotel room), and you can’t deduct purely personal expenses like show tickets and baseball games. Still, this is a great deal taxwise.

Deducting Foreign Travel Costs

When you travel outside the U.S. primarily for business reasons, the general rule is that you must allocate all your travel expenses, including transportation, between business and personal. However, there are two big exceptions, and you often can plan ahead to take advantage of them. You can deduct 100% of your transportation expenses if the trip is primarily for business and you meet either of the following rules:

• The One-week Rule. You’ll meet this rule if your business trip is a week or less, not counting the day you leave, but counting the day you return. In this case, you can deduct 100% of your transportation costs and 100% of your other out-of-pocket expenses for business days (subject to the 50% disallowance rule for meals). You cannot deduct out-of-pocket costs incurred on vacation days. The good news: Weekends and holidays falling between business days count as business days. Ditto for an intervening weekday between two business meeting days. “Standby days” when your physical presence is required for business also count, even if you spend most of your time on personal pursuits during those days. Finally, business days include the day of your return trip plus days you intended to work, but couldn’t due to reasons beyond your control.
• The 25% Rule. You can also deduct 100% of your transportation expenses for trips lasting over a week, as long as you spend less than 25% of your days on vacation. For this purpose, count the day of departure and day of return as business days, as long as you are traveling to or from the business destination. Also, count all the other types of business days mentioned under the one-week rule above. Once again, however, you cannot deduct meals, lodging, and other expenses allocable to personal days.

Even if you don’t qualify for either of the above two exceptions, you (or, more likely, your employer) can still deduct 100% of your transportation costs if you’re traveling on behalf of your employer under a reimbursement or travel allowance arrangement and you’re not a managing executive of the company or related to your employer. Finally, in sort of a catchall provision, 100% of your transportation costs to foreign destinations are deductible if you can prove a personal vacation was not a consideration in choosing to make the trip.

If 100% of your transportation expenses aren’t deductible under any of the above rules, the business percentage of your transportation costs are still deductible—assuming the trip is primarily for business. To calculate the business percentage, divide the days spent principally on business activities by the total number of days outside the country, counting departure and return days. The travel days count as business days, just as the other types of days are considered business days for purposes of the one-week rule and 25% rule. You can also deduct the out-of-pocket expenses allocable to your business days (subject to the 50% disallowance rule for meals).

Example: On Thursday, you fly to Paris for customer meetings on Friday and Monday. You vacation the following Tuesday through Friday and return home Saturday. The two travel days, the two meeting days, and the weekend days in between count as business days. However, the four vacation days amount to 40% of your time, so you fail the 25% test. Therefore, you must allocate your airfare between business and personal. You can deduct 60% of your airfare, plus your out-of-pocket expenses for the six business days.

Example: Same as above, except this time you have only two vacation days (20% of your total days). Remember, the weekend days between your business meetings also count as business days. Now you can deduct 100% of your airfare because you pass the 25% test. You can also deduct your out-of-pocket expenses for the eight business days.

Example: Same as above, except this time you return home on Thursday, three days after concluding your business meetings. Now, your trip is considered to last only a week (the departure day doesn’t count). So, you can deduct 100% of your airfare under the one-week rule. You also deduct your out-of-pocket expenses for all the business days.

Travel to Attend Foreign Conventions

If the reason for a trip outside North America is to attend a business convention directly related to your trade or business, you may qualify for deductions. However, you must follow all of the foreign travel rules just discussed plus show it was just as reasonable for the meeting to be held on foreign soil as in North America and that the time spent in business meetings or activities was substantial when compared to that spent sight-seeing and other personal activities. Otherwise, you can only deduct the registration fees and other costs directly related to business while on your trip. Regardless of the location, you cannot deduct travel costs to attend investment or financial planning conventions and seminars.

Fortunately, the stricter rules for foreign conventions are inapplicable in many cases because the definition of “North America” for this purpose is very liberal. It includes Canada, Mexico, Puerto Rico, the U.S. Virgin Islands, American Samoa, the Northern Mariana Islands, Guam, the Marshall Islands, Micronesia, Palau, Netherlands Antilles, Bahamas, Aruba, Antigua, Barbuda, Barbados, Bermuda, Costa Rica, Dominica, Dominican Republic, Grenada, Guyana, Honduras, Jamaica, Saint Lucia, Trinidad and Tobago, Midway Islands, Palmyra Atoll, Baker Island, Howland Island, Jarvis Island, Johnston Island, Kingman Reef, and Wake Island.

Conventions on Cruise Ships

Deductions related to conventions directly related to your trade or business that are held aboard cruise ships are limited to $2,000 per individual per calendar year. In addition, the ship must be a U.S. registered vessel, and all of its ports-of-call must be in the U.S. or its possessions. Finally, the following information must be attached to your return in the year the deduction is claimed:

1.    A signed statement showing the total days of the trip (excluding travel to and from the ship), the number of hours each day spent attending scheduled business activities, and the program of the convention’s scheduled business activities.

2.    A statement signed by an officer of the sponsoring organization that includes a schedule of each day’s business activities and the number of hours you attended those activities.

Conclusion

We hope this information helps you plan some lovely trips that also deliver some nice tax breaks. However, we realize the rules explained here are rather complicated. Please contact your Wilson Price accountant if you have questions or want more information.

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By Editor, May 4, 2011

IRA owners and beneficiaries who have reached age 70 1/2 are permitted to make cash donations to IRS-approved public charities directly out of their IRAs. These so-called qualified charitable distributions, or QCDs, are federal-income-tax-free to you, but you get no itemized charitable write-off on Form 1040. That’s OK because the tax-free treatment of QCDs equates to an immediate 100% deduction without having to worry about restrictions that can delay itemized charitable write-offs. QCDs have other tax advantages too. Here is what you need to know.

QCD Basics

A QCD is a cash payment of an otherwise taxable distribution, by your IRA trustee, directly to a qualified public charity. The funds must be transferred directly from your IRA trustee to the charity. You cannot receive the funds yourself and then make the contribution to the charity. However, the IRA trustee can give you a check made out to the charity that you then deliver to the charity.

You cannot arrange for more than $100,000 of QCDs in any one year. If your spouse has IRAs, he or she has a separate $100,000 limitation. If you are the beneficiary of an IRA (as opposed to an account owner), you too are eligible for the QCD deal if you are at least age 70 1/2.

You must get and keep substantiation of the contribution from the charity. Also, you must not have received any benefit in return for making the contribution.

The QCD privilege is scheduled to expire at the end of this year, so if you want to take advantage of the idea, it is not too soon to start thinking about it.

Income Tax Benefits

QCDs are not included in your Adjusted Gross Income (AGI). This lowers the odds that you’ll be affected by various unfavorable AGI-based phase-out rules. In addition, you don’t have to worry about the 50%-of-AGI limitation that can delay itemized deductions for garden-variety cash donations to public charities.

QCDs count as a payouts for purposes of the Required Minimum Distribution (RMD) rules. Therefore, you can donate all or part of your 2011 RMD amount (up to the $100,000 limit on QCDs) and thereby convert taxable RMDs into tax-free QCDs.

Does the QCD Deal Work for You?

The QCD privilege is beneficial for seniors in the following circumstances:

• You don’t itemize deductions. Under the “normal” rules, only itemizers get any income tax benefit from charitable donations. Making QCDs will save taxes whether you itemize or not because neither you nor your heirs will ever have to pay income taxes on the donated amounts.
• Your itemized charitable donations would be delayed by the 50%-of-AGI limitation. Making QCDs will avoid this unfavorable limitation.
• You want to avoid being taxed on RMDs that you are forced to take from your IRAs. The QCD strategy does the trick while also allowing you to satisfy your charitable inclinations.

Conclusion

If you’re interested in taking advantage of the tax-saving QCD strategy for 2011, you will need to arrange with your IRA trustee for money to be paid out to one or more qualifying charities by year-end.

If you have questions about QCDs or want more information, your Wilson Price accountant.

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By Editor, April 11, 2011

On April 5, the Senate, by a vote of 87 – 12, approved the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 (the 1099 Act) retroactively repealing the expanded Form 1099 information reporting rules added by recent legislation. The bill was signed by President Obama on April 14^th.

Repeal of Expanded 1099 Reporting Rules for Businesses

Currently, businesses are required to file a Form 1099-MISC to report payments of $600 or more made to persons who provide nonemployee services to the business. Reporting is not required if the payments are made to a corporation.

Effective for payments made after 2011, the Health Care Act extended this 1099 reporting requirement to include gross payments of $600 or more for the purchase of any type of property. It also did away with the exception for corporations. So, thanks to the Health Care Act, starting in 2012, businesses were going to have to report all payments of $600 or more for the purchase of property and services, even those made to corporations.

Businesses quickly cried foul on this recordkeeping and reporting nightmare in the making—not even the IRS liked this provision. Congress and the President agreed on the need for its repeal. But in true Washington fashion, it took awhile. Finally, the 1099 Act repeals the Health Care Act’s extension of the Form 1099 reporting requirements for payments made to corporations and payments made for the purchase of property.

Bottom Line: The Form 1099 reporting rules for businesses do not change after 2011. Thus, businesses will have to report payments of $600 or more to service providers. However, payments to corporations will not need to be reported, nor will payments for property.

Repeal of Expanded 1099 Reporting Rules for Rental Real Estate

Before 2011, the 1099 reporting requirements applied only to payments made in the course of a trade or business. Payments made in a passive investment activity were not subject to these requirements. For payments made after 2010, the Small Business Jobs Act of 2010 (SBA) provided that (with a few exceptions not important for this article) any person receiving rental income from real estate (landlords) would be considered to be engaged in a trade or business and, thus, would be subject to the same 1099 reporting requirements that apply to businesses. Accordingly, thanks to SBA, for 2011, landlords would generally be required to file Form 1099-MISC to report payments of $600 or more made to noncorporate service providers (for things like yard care, painting, and accounting). And, for payments after 2011, they would be required to report payments made to corporations and payments made for the purchase of property just like other honest to gosh businesses.

Fortunately, the 1099 Act repeals the SBA extension of the 1099 reporting requirements to landlords who are not otherwise considered to be engaged in a trade or business of renting property. As a result, landlords making payments of $600 or more to a service provider (such as a plumber, painter, or accountant) will not be required to file Form 1099-MISC, unless their rental activities rise to the level of a trade or business.

Bottom Line: The 1099 reporting rules for landlords do not change after 2010.

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By Editor, February 8, 2011

Information reporting required for rental property expense payments. Beginning with payments made in 2011, recipients of rental income from real estate must implement Form 1099 reporting.   Specifically, rental income recipients making payments of $600 or more to a service provider (such as a plumber, painter, or accountant) in the course of earning rental income are required to provide an information return (typically Form 1099-MISC) to IRS and to the service provider.

This means rental property owners should start now to acquire the names, addresses and social security or other taxpayer identification numbers for service providers, so that this information will be available when the time comes to issue the 1099s.

Exceptions. Exceptions are provided for individuals renting their principal residences (including active members of the military), taxpayers whose rental income doesn’t exceed an IRS-determined minimal amount, and those for whom the reporting requirement would create a hardship (under yet to be issued IRS regs).

Also, 1099-MISC reporting is not required for most payments to corporations during 2011, and is not required for credit card payments, if 1099 reporting for such payments is made by the credit card agency.

Increased information return penalties. For information returns required to be filed after December 31, 2010, the tax penalties for failure to timely file information returns are increased. For example, the minimum penalty for each failure due to intentional disregard will be increased from $100 to $250.

Back up withholding.  A payee furnishes social security number and other 1099 reporting data by completing Form W-9.  If a payee fails to provide such information, the rental property owner must implement 28% back up withholding with regard to such payee.

Illustration : A owns a 12-floor commercial building in the downtown area of City X. A rents out units as office or retail space in the building. A hires a plumber in 2011 to make repairs to the building and pays the plumber $2,000 for 2011. A is considered to be in a trade or business and must file an information return showing the $2,000 payment to the plumber.

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By Editor, November 15, 2010

We’ve already seen legislation with major tax changes this year, and, even though the year is almost over, more legislation is almost certainly on the way. Despite confusion created by the never-ending changes, the 2010 federal income tax environment is still quite favorable. However, we may not be able to say that for 2011 and beyond. Therefore, tax planning actions taken between now and year-end may be more important than ever. Here are some planning ideas to consider while there is still time to act before the year-end.

Some General Comments before We Get Started…

First of all, the goal of year-end tax planning is to identify strategies that will allow you to pay the lowest overall tax. You should look at your tax situation for at least a two-year period, with the objective of reducing your tax liability for the two years combined rather than just for 2010. Also, it’s important to limit tax planning to achieve your financial goals in a tax efficient manner.

Watch out for AMT

While many recent tax-law changes have been helpful in reducing your 2010 regular federal income tax bill, they didn’t do much to reduce the odds that you’ll owe the alternative minimum tax (AMT). Therefore, it’s critical to evaluate all tax planning strategies in light of the AMT rules before actually making any moves. Because the AMT rules are complicated and we still don’t know exactly what they will be for 2010, you may want our assistance.

With these general principles in mind, let’s take a look at some specific tax planning ideas that apply to the vast majority of taxpayers-that is, those in a regular tax situation. Call us if you would like to discuss those that may be appropriate for you or if you want to consider other tax-saving strategies.

Traditional Strategy of Deferring Income Is Dicey This Year

Be careful when considering the time-honored strategy of deferring taxable income from this year into next year. The strategy makes sense if you’re confident you’ll be in the same or lower tax bracket next year, but the tax picture for 2011 is blurry. With just over two months left in 2010, the fate of many tax provisions for 2011 and beyond is still very much unknown. Congress will return to Washington after the November elections to hopefully deal with these issues. In the meantime, we are left with a whole lot of conjecture and very little time for planning once the eventual outcome is known.

The top two rates have widely been expected to increase in 2011 from the current 33% and 35% to 36% and 39.6%, respectively-at least for taxpayers earning $250,000 or more ($200,000 or more if single). Therefore, such taxpayers might want to consider reversing the traditional strategy and accelerating income into 2010 to take advantage of this year’s presumably lower rates. If you’re in business for yourself and a cash-method taxpayer, you may be able to accelerate taxable income into 2010 by sending out client invoices as soon as feasible so that you will receive payment for them in late 2010. You can also increase taxable income by postponing deductible business expenses such as office supplies and repairs and maintenance until next year. If you’re an employee of a family-owned business and it will pay you a bonus for this year, you might want to get it paid in 2010, rather than waiting for 2011.

However, the state of the economy and the November elections results could cause legislators to delay any tax increase to after 2011. Therefore, it may be wise to start now to identify ways you could accelerate some of your 2011 income into 2010, but wait to pull the trigger on them until later in the year when hopefully we will know more.

The conventional wisdom also says that the existing 10%, 15%, 25%, and 28% rate brackets will be left in place for next year. However, Congress must take action for that to occur, and there is not a lot of time left. If Congress fails to act, the four lowest rates will automatically be replaced by three higher rates: 15%, 28%, and 31%. Therefore, individuals in the existing 10%, 15%, 25%, and 28% rate brackets should also be skeptical about following the traditional strategy of deferring income into next year. Again, the best course of action may be to start now to identify ways you could defer or accelerate some of your income between 2010 and 2011, but wait to pull the trigger until we know more. To defer income, you could do just the opposite of what we described earlier (e.g., wait to send invoices until late in the year so payments are received in 2011 and paying deductible business expenses this year). You might also consider setting up a retirement plan and/or making additional deductible retirement plan or IRA contributions for the year.

We wish we could give you more definitive advice about the advisability of deferring income (or not), but the uncertainty about future tax rates makes it difficult. Please check back with us later when we may have much better intelligence about what’s going to happen with 2011 tax rates-hopefully, this will be before the end of 2010.

Higher-income Individuals May Benefit from Accelerating Itemized Deductions into This Year

For 2010, the phase-out rule that previously reduced write-offs for the most popular itemized deduction items (including home mortgage interest, state and local taxes, and charitable donations) is gone. However, the phase-out rule is scheduled to come back with a vengeance in 2011 unless Congress takes action to prevent it, which looks increasingly unlikely. If the phase-out rule comes back as expected, it will wipe out $3 of affected itemized deductions for every $100 of Adjusted Gross Income (AGI) above the applicable threshold. Individuals with very high AGI can see up to 80% of their affected deductions wiped out. For 2011, the AGI threshold will probably be around $170,000, or around $85,000 for married individuals who file separate returns.

Bottom Line

Depending on your AGI, you may get more tax-saving benefit from accelerating into 2010 your state and local tax payments that are due early next year and some charitable donations that you’d normally make in 2011. However, things get a bit tricky if you’ll be subject to the AMT this year. Please contact us if you have questions about the advisability of accelerating itemized deductions into this year.

Time Investment Gains and Losses and Consider Being Bold

As you evaluate investments held in your taxable brokerage firm accounts, consider the impact of selling appreciated securities this year instead of next year. The maximum federal income tax rate on long-term capital gains from 2010 sales is 15%. However, that low 15% rate only applies to gains from securities that have been held for at least a year and a day. In 2011, the maximum rate on long-term capital gains is scheduled to increase to 20%. That will happen automatically unless Congress takes action, which looks increasingly unlikely right now.

To the extent you have capital losses from earlier this year or a capital loss carryover from pre-2010 years (most likely from the 2008 stock market meltdown), selling appreciated securities this year will be a tax-free deal because the losses will shelter your gains. Using capital losses to shelter short-term capital gains is especially helpful because short-term gains will be taxed at your regular rate (which could be as high as 35%) if they are left unsheltered.

What if you have some loser securities (currently worth less than you paid for them) that you would like to dump? Biting the bullet and selling them this year would trigger capital losses that you can use to shelter capital gains, including high-taxed short-term gains, from other sales this year. If you think your investments that are currently underwater are poised for a comeback, you can buy them back after taking a loss as long as you don’t reacquire them within 30 days before or after the sale.

If selling a bunch of losers would cause your capital losses for this year to exceed your capital gains, no problem. You will have a net capital loss for 2010. You can then use that net capital loss to shelter up to $3,000 of this year’s high-taxed ordinary income from salaries, bonuses, self-employment, and so forth ($1,500 if you’re married and file separately). Any excess net capital loss gets carried forward to next year.

Important Point

Selling enough loser securities to create a big net capital loss that exceeds what you can use this year might turn out to be a pretty good idea. You can carry forward the excess net capital loss to 2011 and beyond and use it to shelter both short-term gains and long-term gains recognized in those years. This can give you extra investing flexibility in future years because you won’t necessarily have to hold appreciated securities for over a year to get better tax results. Remember: It’s widely expected that the maximum federal income tax rate on long-term capital gains will be increased to 20% after 2010 (up from the current 15%). Also, the top two federal rates on ordinary income, including short-term capital gains, are scheduled to be increased starting in 2011 to 36% and 39.6% (up from the current 33% and 35%). Contact us if you want help in identifying your best tax-smart options in a world where future tax rates are uncertain, but likely are heading higher.

Convert Traditional IRA into Roth IRA

If your traditional IRA has dropped in value and you expect to pay higher federal income tax rates in future years, now might be a very good time to consider converting all or part of your traditional IRA balance into a Roth IRA. Here’s why. If you convert, it will trigger a current tax hit on the amount you convert. But, with your traditional IRA balance at a depressed level (and possibly your overall income too), the tax hit will be less. After the conversion, all the income and gains that accumulate in your Roth IRA, and all withdrawals after you reach age 59¹/₂, will be totally free of any federal taxes-assuming you meet the tax-free withdrawal rules. In contrast, future withdrawals from a traditional IRA could be hit with tax rates that are higher than today’s rates (maybe much higher depending on how things go).

Before this year, there were two big restrictions on the Roth IRA conversion privilege. First, your Modified Adjusted Gross Income (MAGI) could not exceed $100,000. Second, you were completely ineligible if you used married filing separate status. For 2010, both restrictions are eliminated. Now, virtually anyone who owns a traditional IRA can do a Roth IRA conversion.

Of course, conversion is not a no-brainer. You have to be satisfied that paying the upfront conversion tax bill makes sense in your circumstances. In particular, converting a big account all at once could push you into higher tax brackets, which would not be good. However, for 2010 conversions only, you can elect for federal income tax purposes to spread the income triggered by conversions evenly over 2011 and 2012 and thereby defer the related federal income taxes. You must also make assumptions about future tax rates, how long you will leave the account untouched, the rate of return earned on your Roth IRA investments, and so forth. If the Roth IRA conversion idea intrigues you, please contact us for a full analysis of all the relevant variables.

Ideas for Your Business

Consider Paying a Dividend in 2010. If you’re a shareholder in a closely held C corporation, the current federal income tax rate structure is helpful to your cause. If the company pays you a taxable dividend in 2010, the maximum federal rate is only 15% (it is 0% to the extent you are in the 10% or 15% ordinary income tax brackets). However, this may well change in the near future. Thus, now may be a good time to convert some of your C corporation wealth into personal cash at a very manageable tax cost (and possibly none at all). Although the current administration has stated that it wants to hold the dividend tax rate to 20%, unless Congress acts soon, the maximum federal rate on dividends is scheduled to skyrocket from the current 15% to 39.6% starting with 2011.

Take Advantage of Tax Breaks for Purchasing Equipment, Software, and Certain Real Property. If you have plans to buy a business computer, office furniture, equipment, vehicle, or other tangible business property or to make certain improvements to real property, you might consider doing so before year-end to maximize your 2010 deductions. Here’s why.

•   Bigger Section 179 Deduction. Your business may be able to take advantage of the temporarily increased Section 179 deduction. Under the Section 179 deduction privilege, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions. Thanks to the Small Business Jobs Act passed in late September, for tax years beginning in 2010 and 2011, the maximum Section 179 deduction is a whopping $500,000, as long as the amount of qualifying property placed in service during the year does not exceed $2 million. Furthermore, for the first time, up to $250,000 of some types of real property can qualify, including restaurant buildings and improvements made to interiors of retail and leased nonresidential buildings.

Note:  Watch out if your business already has a tax loss for the year (or is close to it) before considering any Section 179 deduction. You can’t claim a Section 179 write-off that would create or increase an overall business tax loss for the year. Please contact us if you think this might be an issue for your operation.

•  50% First-year Bonus Depreciation.  Above and beyond the bumped-up Section 179 deduction, your business can also claim first-year bonus depreciation equal to 50% of the cost (reduced by the Section 179 deduction) of most new (not used) equipment, software, and qualified leasehold improvements placed in service by December 31 of this year.

Claim New Health Insurance Tax Credit for Small Employers. Qualifying small employers can claim a new tax credit that can potentially cover up to 35% of the cost of providing health insurance coverage to employees. A qualifying small employer is one that: (1) has no more than 25 Full-time Equivalent (FTE) workers, (2) pays an average FTE wage of less than $50,000, and (3) has a qualifying healthcare arrangement in place.

A qualifying arrangement is one that requires the employer to-(1) pay at least 50% of the cost of each enrolled employee’s coverage, and (2) pay the same percentage for all employees. For tax years beginning in 2010, however, a favorable transition rule allows the credit to be claimed when the employer does not pay the same percentage for each enrolled employee, but instead pays for each enrolled employee an amount equal to at least 50% of the cost of single coverage (even if the employee has more-expensive family or self-plus-one coverage).

The allowable credit is quickly reduced under a complicated two-tiered phase-out rule when the employer has more than 10 FTE employees or an average FTE wage in excess of $25,000. Please contact us if you have questions about this new break.

Social Security Tax Exemption for Wages Paid to New Hires. Wages paid to a qualified new employee between March 19, 2010 and December 31 2010 are exempt from the employer’s portion of the Social Security tax (the employer portion equals 6.2% of wages up to $106,800). The exemption doesn’t apply to the employee’s portion of the Social Security tax (also 6.2% of wages of up to $106,800). Qualified new employees are full-time or part-time workers who-(1) start work after February 3, 2010 and by no later than December 31, 2010, and (2) were not employed more than 40 hours during the 60-day period ending on the start date. The new worker cannot displace a current employee unless that person quit voluntarily or was discharged for cause. Wages paid to workers who are related to an owner of the employer may be ineligible. Please contact us if you think you might qualify for this tax break.

Tax Credit for Retaining New Hires. Above and beyond the Social Security tax exemption, employers can also claim a new tax credit of up to $1,000 for wages paid to each qualified new employee(defined the same way as for the Social Security tax exemption). However, there are some additional requirements to collect this break. You must keep the worker on the payroll for at least 52 consecutive weeks, and wages during the second 26 weeks must equal at least 80% of wages paid during the first 26 weeks. The credit equals the lesser of-(1) 6.2% of qualifying wages paid during the 52-consecutive-week period or (2) $1,000. To claim the maximum $1,000 credit, the worker must be paid at least $16,130 during the 52-week period. Also, the credit is claimed in the tax year that the 52-week period is met for the worker. Therefore, the credit will be claimed on your 2011 return. Still, you have to get the ball rolling by hiring the new employee in 2010.

Ideas for the Office

Maximize Contributions to 401(k) Plans. If you have a 401(k) plan at work, it’s just about time to tell your company how much you want to set aside on a tax-free basis for next year. Contribute as much as you can stand, especially if your employer makes matching contributions. You give up “free money” when you fail to participate to the max for the match.

Take Advantage of Flexible Spending Accounts (FSAs). If your company has an FSA, before year-end you must specify how much of your 2011 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying child care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts-you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year. And, starting in 2011, over-the-counter drugs (e.g., aspirin and antacids) will no longer qualify for reimbursement by FSAs so you may need to consider that when you determine your 2011 contribution amount.

If you currently have an FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early. Also, for 2010, over-the-counter drugs still count.

Adjust Your Federal Income Tax Withholding. If it looks like you are going to owe income taxes for 2010, consider bumping up the Federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your 2010 liability or, if smaller, 100% of your 2009 liability (110% if your 2009 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized, if not eliminated.

Make Energy Efficiency Improvements to Your Home

A great way to cut energy costs and save up to $1,500 in federal income taxes this year is to make energy efficiency improvements to your principal residence. Basically, if you install energy efficient insulation, windows, doors, roofs, heat pumps, furnaces, central A/C units, hot water heaters or boilers, or advanced main air circulating fans to your home during 2010, you may be entitled to a tax credit of 30% of the purchase price. However, the maximum total credit you can claim for 2009 and 2010 combined is limited $1,500. Absent Congressional action, the credit won’t be available after 2010.

Retirement Plan Distributions for Seniors Age 70¹/₂ Plus

The tax laws generally require individuals with retirement accounts to take withdrawals based on the size of their account and their age every year after they reach age 70¹/₂. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. A temporary tax law change waived the minimum distribution requirement for 2009 only. This waiver does not apply for 2010. So, if you are age 70¹/₂ or older, you generally must take your required distribution before the end of the year to avoid the penalty. However, if you turned age 70¹/₂ in 2010, you can delay your 2010 required distribution to 2011 if you choose.

But, waiting until 2011 will result in two distributions in 2011-the amount required for 2010 plus the amount required for 2011. While deferring income is normally a sound tax strategy, here it results in bunching income into 2011. Thus, think twice before delaying your 2010 distribution to 2011-bunching income into 2011 might throw you into a higher tax bracket or have a detrimental impact on your other tax deductions. Barring year-end tax legislation, tax rates could be higher next year as well.

Conclusion

As we said at the beginning, this is intended to give you just a few ideas to get you thinking about tax planning moves for the rest of this year. Please don’t hesitate to contact us if you want more details or would like to schedule a tax planning strategy session.

Circular 230 Notice: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.