Business & Tax Planning Ideas for Our Clients and Friends
Special Tax Issue
Tax planning is something most people don't want to take time to do, especially during
the busy fall season. But a few moments of planning now can make a big difference on your
tax bill next April.
Capital gains and losses
Stock market investments can have significant tax consequences. Knowing the tax rules
may affect your investment strategies and help you make informed decisions.
Timing. Be aware of the impact the timing of capital gains may have in other areas.
Capital gains are fully included for determining the adjusted gross income (AGI) amount,
even though it is only taxed at a maximum 20% rate. AGI is used to measure whether a
taxpayer is eligible for such tax benefits as the child credit, Roth IRA contributions and
rollovers, and education incentives.
Use the capital gains rate to your advantage. Try to only sell shares you've held for
more than 12 months. That way you'll qualify for the more favorable long-term 20% capital
gains tax rate (10% for taxpayers in the 15% tax bracket).
Use your losses in two ways. If your investments saw considerable gains in 1999,
search your portfolio for offsetting losses. Conversely, if you expect high losses next
year, try to postpone realizing gains until then. In addition, you're allowed to write off
losses dollar for dollar against your gains plus $3,000 of ordinary income. If you have no
gains, you can still deduct the losses against up to $3,000 of ordinary income.
Generate a loss, then repurchase a stock. If you think your depressed fund or stock
will bounce back, but you'd still like to generate a taxable loss, you can sell it and
then buy it back. But make sure you wait more than 30 days after the date of sale before
you buy it back. If you buy or sell identical securities prior to this period (30 days
before or 30 days after the date of sale), the so-called "wash-sale rule" won't
let you take a loss.
Don't buy mutual funds at the end of the year. Fund companies usually distribute all
their capital gains and dividends at year-end, and you'll be taxed on the payout without
enjoying any increase in the value of your investment.
Miscellaneous expenses are deductible only to the extent that they surpass 2% of your
AGI. Expenses that qualify as miscellaneous generally fall into one of three categories:
employment or business, investment, or tax. If your miscellaneous expenses are near the 2%
limit, try to bunch them into alternate years to increase your deduction. To bulk up,
consider investing in job-related equipment and training. Other options include paying
next year's professional dues, subscriptions, and investment management fees in late 1999.
As long as you itemize, charitable donations remain fully deductible, but there are
deduction ceilings for very substantial contributions. For cash contributions, the
deduction ceiling is generally 50% of your AGI. For appreciated property donations, the
deduction limit is generally 30% of AGI. Make sure you have a contemporaneous written
receipt from the charity for single donations of $250 or more. A canceled check is not
sufficient proof for tax purposes.
If you donate securities held for more than 12 months, not only will you reduce your
taxable income, but you can take a deduction for the fully appreciated market value of the
stock and also avoid capital gains tax on the sale.
Lifetime Learning Credit. This credit allows you to claim 20% of the first $5,000 in
education expenses (a $1,000 maximum credit). It applies to fees incurred by a qualified
dependent, your spouse, or yourself to attend an accredited college, university, or
vocational school leading to a bachelor's degree, an associate's degree, or another
recognized post-secondary credential. The Lifetime Learning Credit is phased out for
taxpayers with modified AGI between $40,000 and $50,000 (between $80,000 and $100,000 for
Hope Scholarship Credit. You're allowed a credit of up to $1,500 (100% of the first
$1,000 in tuition, 50% of the second $1,000 in tuition) for your dependent children who
are students, but the credit applies only to a student's first two years of post-secondary
education. The Hope Scholarship Credit is subject to the same phase-outs as the Lifetime
Education IRA. Eligibility for education IRAs phases out for single taxpayers with
modified AGI between $95,000Ð$110,000, and between $150,000Ð$160,000 for joint returns.
If you qualify, earnings accumulate tax-free and there will be no tax on withdrawal if the
money is used for qualified education expenses. If the money in an Education IRA is not
used (or is not rolled over into another education IRA) by the time the child is 30, the
beneficiary will be taxed on the earnings and will owe a 10% tax penalty.
Note: The Hope Scholarship Credit, the Lifetime Learning Credit, as well as tax-free
withdrawals from Education IRAs, are mutually exclusive. You can elect to use only one of
To fully take advantage of the Hope and Lifetime Learning Credits, some postponing or
accelerating of tuition payments is often needed. If parents are over the AGI level
allowed for taking the Lifetime Learning Credit, they might consider having the student
take the credit. This requires that the student not be claimed by the parent as an
IRAs and other accounts
Plan to make maximum contributions to your Individual Retirement Account (IRA). Even
if you can't deduct your contributions, IRAs might still make tax sense since earnings
grow, tax-deferred, until withdrawn.
Roth IRAs. Withdrawals of the contributions and earnings are tax free, as long as the
account has been open for at least five years and you have reached age 591/2, or on or
after death or disability. In addition, contributions may be made after you reach age
701/2 and you can leave amounts in your Roth IRA as long as you live. A rollover to a Roth
IRA is attractive if you expect to be in the same or higher tax bracket in retirement. A
rollover is not as attractive if you will be in a substantially lower tax bracket at
retirement and if you lack the funds to pay the tax resulting from the conversion.
Note: If you convert your traditional IRAs into a Roth IRA in 1999, you'll pay tax on
the conversion income in 1999. There is no option to spread the income over four years as
Since only medical expenses that surpass 7.5% of your AGI are deductible, be sure to
total them before year-end to see if you are near the limit. If you are, accelerate
elective medical procedures into this year to increase your deduction. Otherwise, postpone
any non-essential medical expenses until next year. When making your calculation, don't
forget to include doctor bills, prescriptions, insurance premiums, and transportation
costs to and from medical facilities. Many other expenses qualify, such as eyeglasses,
wheelchairs, contact lenses, braces, orthopedic shoes, and hearing aids.
Before the end of the year, match your withholding to your estimated tax liability. If
you've moved up to a higher tax bracket, adjust your withholding or you may be hit with an
underpayment penalty. Conversely, you may be giving the IRS more than you need to; if you
received a tax refund last year, you may want to adjust your withholding and invest the
Put off that bonus. Ask your employer to defer paying your year-end bonus until after
the first of the year.
Accelerate itemized deductions not subject to income thresholds. Make your January
2000 mortgage payment or home equity loan payment in late 1999. Pay state or local taxes
early by making your January 2000 estimated tax payments in late 1999. Increase your state
or local tax withholding for the rest of the year.
If you have any tax-planning questions, please contact our office.
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If you're not entirely clear on what constitutes a deductible business expense, you're
not alone. Many business owners are unsure about what they can and cannot deduct. To use
the IRS's terms, almost any "ordinary and necessary" expense that is
"reasonable and customary" qualifies as a deductible business expense. The words
reasonable and customary refer to your specific business and the business customs in your
area. For example, if you're in the advertising business, you may be able to deduct just
about every newspaper and magazine you buy because an awareness of trends in advertising
is central to your business. The same deduction would not be available to you if you have
a catering business.
Current versus capital expenses
Before discussing specific deductions, you need to know the difference between current
expenses and capital expenses that must be depreciated. Current expenses, which include
the everyday costs of keeping your business going, such as office supplies, rent, and
electricity, can be deducted in the year you incurred them. But expenditures for things
that will generate revenue in future years(a desk, a copier machine, or a car, must be
depreciated)that is, written off over their useful life. According to IRS rules, that
period is usually three, five, or seven years.
There is an important exception to this rule(the expensing deduction, a special tax
break for smaller businesses. Under Section 179 of the Tax Code, in 1999, you can
immediately write off up to $19,000 in equipment purchases, rather than depreciating their
cost over a period of years. In addition, the equipment purchases are eligible for a full
write-off under the expensing method no matter how late in the year the purchases are
made. If you charge the purchase on a credit card before the end of the year and do not
get billed until January, you can still take the deduction in 1999, as long as you placed
the asset in service before the end of the year.
Expensing gives you an immediate deduction, but there are a few rules you need to
know. The amount you can write off immediately is limited to the amount of taxable income
you have from your business. Special restrictions also apply to personal computers,
cellular phones and certain other equipment. Generally, these items must be used more than
50% of the time for business in order to qualify for expensing.
As a general rule, it's a good idea to place new equipment into service before the end
of the year. Under the "mid-year convention," business assets placed in service
during the latter half of the year are treated as if they had been placed in service on
July 1 for purposes of computing depreciation deductions. In other words, you may be able
to claim the equivalent of a half-year's worth of depreciation(even if you use the
equipment only for a few days in December. However, a special tax rule is triggered if you
place too much equipment in service at year-end. Specifically, if the cost of business
assets placed in service during the last quarter of 1999 exceeds 40% of the cost of all
business assets put in service during the year, your depreciation deductions for all
assets placed in service during the year are figured under the mid-quarter convention,
which will dramatically reduce your annual depreciation deduction.
Businesses may contribute cash or property to charities. Unincorporated business
owners may make and fully deduct cash gifts of up to 50% of adjusted gross income and may
contribute appreciated property of up to 30% of adjusted gross income. Unless your
business is a C corporation, you deduct charitable contributions by the business on
Schedule A of your
personal tax return. A corporation may deduct on its corporate return
charitable contributions that total no more than 10% of the corporation's modified
taxable income. A considerable tax advantage exists for business owners who donate
property that has appreciated in value. In addition to a deduction for the full market
value of the property, the donor avoids tax on the appreciation that has built up.
If you use your personal car for business, or your business owns its own vehicle, you
can deduct some of the costs connected with keeping your car running. There are two
methods of claiming automobile expenses. You can either keep track of and deduct all your
actual business-related car expenses, including gas and oil, repairs and maintenance,
depreciation, insurance, tires, or you can simply take the standard mileage rate. This
rate is set by the IRS and is adjusted annually. For 1999, the standard mileage rate was
lowered, effective April 1, to 31 cents for each business mile driven. If you're not sure
which method to use, as a general rule, if you have a newer car and you use it primarily
for business, the actual expense method is likely to provide a larger deduction.
When you travel for business, you can deduct many expenses, including the cost of
plane fare, taxis, lodging, meals, and telephone calls, etc. If you extend your stay to
take advantage of the "Saturday overnight requirement" for discounted airfare,
your hotel room and meals would be deductible.
As a business owner, if you entertain clients or customers, you can deduct 50% of your
qualifying business meal and entertainment expenses. Enter-taining guests at restaurants,
nightclubs, theatres, sporting events ( any activity considered to provide entertainment,
amusement, or recreation(falls into this category. Meal and entertainment expenses qualify
for a deduction if they meet at least one of two tests. The entertainment must be
"directly related" to the active conduct of your business, which means business
is the primary purpose of the meal or entertainment expense, or it must be
"associated with" business, which means even if you don't discuss business at
the meal, the meal or entertainment expense precedes or follows a substantial business
discussion. For example, catering lunch for a business meeting would be a "directly
related" expense, while meeting a client to discuss a proposal and then taking him or
her to a ball game would fit the "associated with" requirement.
Note: Holiday parties, picnics and other social events you put on for your employees
and their families are an exception to the 50% rule; such events are 100% deductible.
If you give gifts to clients in the course of your business, especially during the
year-end holiday season, you can deduct up to and including $25 for business gifts you
give to any one person during the tax year. Any amount in excess of $25 is disallowed as a
deduction. The $25 limit doesn't include shipping or engraving.
Bad debts and casualty losses
If a customer or vendor doesn't pay your invoice, that bad debt may or may not be
deductible; it depends on what you're billing for. If your business sells goods, you
typically can deduct the cost of goods you sell but don't get paid for. But before you can
claim a bad debt write-off, the IRS requires that you take reasonable steps to collect
payment. That can include giving the debtor written warnings or going to a collection
agency or small-claims court. Since a bad debt deduction can only be taken in the year in
which the debt becomes totally worthless, you should step up your collection efforts if
you have some bad debts you want to write off this year.
Unfortunately, if your business provides a service such as writing or consulting, you
cannot deduct an unpaid bill as a bad debt. No tax deduction is allowed for time you
devoted to a client who doesn't pay. The rationale behind the rule is that it would be too
easy for businesses to inflate bills and claim large deductions for bad debts.
As many small business owners have learned during the past few years, hurricanes,
floods, tornadoes and blizzards can do severe damage to business property. If your
business property is damaged or destroyed due to some unforeseen event such as one of
these, you may be entitled to deduct the loss. A special rule applies to business property
that is completely destroyed as a result of a casualty loss. In such cases, your loss is
your basis in the property without regard to fair market value. There are no dollar
limitations on these losses as there are on personal losses, nor are there any adjusted
gross income limitations. You must, however, reduce your loss by the amount of any
insurance reimbursement you receive.
Home office deduction
As of January 1, 1999, the home office deduction rules became more lenient. The
Taxpayer Relief Act of 1997 made the home office deduction more accessible by expanding
the definition of "principal place of business." The new definition benefits
those self-employed persons who manage a business from their homes, but also provide a
service or meet clients at another location. An example would be a doctor who sees
patients at local clinics, but conducts the administration or management activities of the
business from a home office. A home office now qualifies as your principal place of
business if you use it regularly and exclusively to conduct the administrative or
management activities of a business and there is no other fixed location where you conduct
substantial administrative or management activities.
Health insurance deduction
If you are self-employed, for 1999, you are eligible to deduct 60% of the cost of
health insurance to cover you, your spouse, and your dependents. This above-the-line
deduction is available whether or not you itemize. Assuming you itemize, you can add the
remaining 40% of what you pay for health insurance to your medical expenses. If the total
of your itemized medical expenses exceeds 7.5% of your adjusted gross income (AGI), all
your medical expenses become tax deductible.
Expenses of going into business
The cost of investigating the potential for a new business and getting that business
started are capital expenses, which can be recovered by depreciation or amortization.
Under tax law, you may elect to depreciate or amortize your start-up costs over a period
of 60 months or more if two conditions are met: (1) those costs would be deductible if
they were paid or incurred to operate an existing business and, (2) the costs were paid or
incurred before you actually began business operations. If you decide not to go into
business, any costs you paid to investigate the possibility of going into business are
considered personal costs and are not deductible. Costs you paid in your attempt to
actually start or purchase a specific business can be claimed as a capital loss.
Medical Savings Accounts
Medical Savings Accounts (MSAs) are designed to work in conjunction with
high-deductible health insurance plans and are available to self-employed individuals and
owners and employees of small businesses. MSAs are similar to IRAs in the sense that
employers and employees can make tax-free contributions to the MSA. Instead of withdrawing
the funds at retirement, the taxpayer withdraws the funds to pay for qualified medical
expenses. Assets not spent on medical expenses accumulate from year to year and can remain
invested on a tax-deferred basis to fund future medical expenses or to supplement the
taxpayer's retirement savings.
Goods that cannot be sold at normal selling prices or in the usual way because of
changes of style or damage may be valued for deduction purposes at bona fide selling
prices, less the direct costs of disposition. To realize expected losses, take steps to
dispose of obsolete inventory.
If you're like many small business owners, you regularly spend small amounts of cash
on things like pens, taxis, and postage stamps. While these may not seem like large
outlays at the time, over the course of a year, they can add up. For example, suppose you
stock your office lunchroom with coffee, soft drinks, and snacks. That $25-a-month outlay
translates into a $300 expense over the course of a year and it is all deductible. One way
to improve your cash expense recordkeeping is to reimburse yourself by check. Every few
weeks, tally your cash receipts and write yourself a business check for the amount you
spent. You don't necessarily need a receipt for items under $75; just be sure to keep good
records. One way to do so is to put all of your small business purchases on a corporate
charge card that provides you with regular management reports. This will save you time and
money during tax preparation time.
IRS studies show that poor records, not dishonesty, cause most small business people
to lose at audits or fail to comply with their tax reporting obligations. It's important
to keep detailed records of expenses for travel away from home, business meals and
entertainment, business gifts, automobile expenses and others.
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In October 1994, the taxpayers were telephoned by an IRS agent in the El Paso, Texas
office, who indicated there would be an examination of the taxpayers' 1991 and 1992 tax
returns. In November 1994, the taxpayers' representative wrote the IRS agent, asking that
the location of the examination be held in Dallas, as all the taxpayers' records, books,
and source documents for 1991 and 1992 were at that office. The IRS had not stated what
specific matters were to be addressed in the examination. Because of the transfer, the IRS
asked the taxpayers to consent to extending the period of limitations for the 1991 income
tax year to June 30, 1996. The extension was made for 1991, but the 1992 limitations date
remained the same.
The files were transferred to the Dallas office, 161/2 months before the limitations
period for 1991 would have expired, but the case was not assigned to an IRS agent until
101/2 weeks before the limitations period expiration. The agent then called the taxpayers'
representative and asked for extensions of the limitations period, but the taxpayers'
representative expressed reluctance because he had already consented to one extension. At
the meeting, the taxpayers responded to the agent's questions for two hours. Two days
later, the agent prepared Form 872 to extend the limitations period and tried contacting
the taxpayers' representative via telephone for the next two weeks. The agent went to the
taxpayers' representative's office with the Form 872. The representative refused to sign
the Form 872, stating that he was willing to consent to an extension of the limitations
period if the agent was willing to limit the scope of her examination. The agent refused
to agree to this without speaking with her manager. Also at this meeting, the
representative noted that he had never received an Information Document Request (IDR) for
the years in question. She offered to give to him the IDR that she had prepared for the
April 23 meeting, but he refused to accept it.
The next day the IRS issued a notice of deficiency for the 1991 and 1992 tax returns.
The taxpayers then filed a petition with the Tax Court.
Result: The Tax Court agreed with the taxpayers, and found that the IRS had made no
attempt to obtain information and had failed to diligently investigate the case. The court
also stated that the taxpayers were not blameless(their representative could have asked
for an IDR or other listing of documents that the IRS needed, but did not do so. The
representative should have returned the agent's phone calls, but the only indication in
the record as to the purpose of these calls was that that agent wanted a limitations
extension and not substantiation materials. But the court found the IRS agent could and
should have served an IDR at the meeting. Instead, she withheld the already prepared IDR
and did not otherwise ask for any substantiation at the meeting. Because the IRS had
"frittered away" the bulk of the extension already granted by the taxpayers, the
IRS was then required to take its position in this case. At the time of the IRS's answer
to the Tax Court petition, it did not have any substantiation, because it had not asked
for it. The court concluded: "Thus, the (IRS) created the very problem that the IRS
seeks to use as an excuse," and held for the taxpayers. Maddox v. Commissioner, T.C.
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Employers. For Social Security, Medicare, and withheld income tax, file Form 941 for
the third quarter of 1999. Deposit any undeposited tax. If the total is less than $1,000
and not a shortfall, you can pay it with the return. If you have deposited the tax for the
quarter in full and on time, you have until November 10 to file the return.
For federal unemployment tax, deposit the tax owed through September if it is more
Employees who work for tips. If you received $20 or more in tips during October,
report them to your employer. You can use Form 4070.
Employers. For Social Security, Medicare, and withheld income tax, file Form 941 for
the third quarter of 1999. This due date applies only if you deposited the tax for the
quarter in full and on time.
Employers. For Social Security, Medicare, withheld income tax, and nonpayroll
withholding, deposit the tax for payments in October if the monthly deposit rule applies.
Employees who work for tips. If you received $20 or more in tips during November,
report them to your employer. You can use Form 4070.
Employers. For Social Security, Medicare, withheld income tax, and nonpayroll
withholding, deposit the tax for payments in November if the monthly deposit rule applies.
Corporations. Deposit the fourth installment of estimated income tax for 1999. A
worksheet, Form 1120-W, is available to help you make an estimate of your tax for the
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