Tax Calendar
2008 Offers Many Tax Benefits
Zero Capital
Gains Rate in 2008 Requires Careful Planning
Disposing of Business Assets Without the Tax Bite
Avoiding the IRS Audit Net
Employers Beware! New Form Available to Misclassified Workers
Since You Asked…
March 17, 2008:
· 2007 calendar year Corporation and S Corporation returns are due, including any taxes owed. This is also the due date for providing Schedule K-1 to the S Corporation shareholders. If you cannot complete and file the Corporation return by the March due date, file for the automatic six-month extension to give yourself until September 15 to file the return.
· – This is the due date for electronically filing (not by magnetic media) 1099 forms, W-2 forms, W-2G forms and tip reporting. File these forms electronically if you did not previously file by other means on February 28.
· This is the last day to withdraw funds from your Traditional IRA if you turned age 701/2 in 2007 and haven’t taken your 2007 distribution yet. In addition, this is the last day to withdraw funds from your SEP or Keogh plan if you are retired and turned age 701/2 in 2007. Failure to take the required distributions could result in substantial penalties.
· First quarter estimated tax installment payment for the 2008 tax year is due.
· Filing due date for your 2007 income tax return and to pay any taxes that are due. If you expect to owe, estimate how much and include your payment with the extension. If you owe taxes when you do file your extended tax return, you will be liable for both the late payment penalty and interest from the due date.
· Filing due date for the 2007 calendar year Partnership return(s) and to provide Partnership Distribution Forms (Form K-1) to the partners. If you cannot file a Partnership return by the April due date, file for the automatic six-month extension to give yourself until October 15.
June 16, 2008(1):
· The second installment of your 2008 individual estimated taxes is due. If your income or deductions have changed significantly, you should call this office to determine if any adjustment in estimates is appropriate.
· U.S. citizens living abroad on April 15, 2008 must file a 2007 income tax return (if not already filed) or file for an extension.
June – July 2008:
· Time to review your 2008 year-to-date income and expenses to ensure your estimated tax payments and withholding are adequate to avoid underpayment penalties.
(1) Normally this date falls on the 15th of the month. However, when falling on a Saturday, Sunday or holiday, it becomes the next business day.
Several new laws were enacted in December of 2007 that will affect taxpayers in 2008. The following is an abbreviated summary of each of these new tax provisions. Please give us a call for additional details if you believe any of these may impact you.
Home Mortgage Debt Forgiveness – Generally, any forgiven debt becomes taxable income to a taxpayer unless they qualify for exclusion of the debt income under an insolvency exception. Addressing the subprime lending crisis, Congress passed a law providing tax relief to homeowners for up to $2 million ($1 million for married taxpayers filing separately) of forgiven debt on a primary residence. The basis of the taxpayer’s home is reduced by the excluded amount, which will result in a potentially larger gain for properties foreclosed upon and for homes that are sold in the future. If a taxpayer qualifies, the home sale exclusion can be used to offset up to $250,000 of gain for each owner. The provision is retroactively effective for 2007 through 2009.
Caution! The exclusion applies only to the discharge of debt incurred to buy or substantially improve the taxpayer’s primary home (acquisition debt) and does not cover debts incurred to pull equity out of the home for other purposes. Acquisition debt includes refinanced debt to the extent the amount of the refinancing doesn't exceed the amount of the acquisition debt at the time of the refinance.
Mortgage Insurance Premium Deduction Extended – The mortgage insurance premium deduction, which was originally available only in 2007, was extended for three years and will be deductible through 2010. This provision permits taxpayers to treat certain amounts paid for qualified mortgage insurance as home mortgage interest, but is phased out at higher levels of adjusted gross income (AGI). To be deductible, the insurance must be in connection with home acquisition debt, the insurance contract must have been issued after 2006, and the taxpayer must pay the premiums for coverage in effect during the year. There are special rules for allocating prepaid premiums.
Home Sale Exclusion Liberalized for Surviving Spouse – Prior to the passage of this new legislation, a surviving spouse could use the up-to-$500,000 home sale gain exclusion only if he or she had filed a joint return with the deceased spouse for the year of sale. That meant the higher joint exclusion was allowed only if the home had been sold in the year of the deceased spouse’s death. Thus, if the home were sold in a year after the year of a spouse's death – when a joint return would no longer be allowed to be filed – the surviving spouse could get a maximum home sale gain exclusion of only $250,000.
For sales and exchanges after Dec. 31, 2007, a new law allows a surviving single spouse to qualify for the $500,000 exclusion if the sale occurs no later than 2 years after the deceased spouse's death, and the couple otherwise meets the qualifications for the $500,000 exclusion immediately before the spouse's death.
This may or may not be beneficial, since a surviving spouse, depending upon the state of residence and the manner in which the title is held, will have a 50% or 100% step up (or step down) in basis of the home as a result of the spouse’s death. So, a sale within the two-year period after the spouse’s death may not result in a gain in excess of $250,000 anyway – at least in the current real estate market in most locations. But for those surviving spouses who do have a home sale gain greater than $250,000, this new law will be a significant benefit.
Tax Relief for Volunteer Responders – Another provision included in the December tax law changes, effective in 2008 through 2010, was a provision that creates an exclusion from income for certain state or local tax benefits (a rebate or reduction of state or local income or property tax) and qualified payments (up to $360 a year) granted to members of qualified volunteer emergency response organizations. This would include state or local organizations whose members provide volunteer firefighting or emergency medical services.
These are not the only tax changes you can expect in 2008. Congress is worried about a recession and is currently considering economic stimulus provisions. When we will see the new legislation is anyone’s guess. Hopefully, it will be a lot quicker than last year and instead of the usual patches we’ve had in prior years, there will be a meaningful solution to the alternative minimum tax (AMT).
One of the greatest benefits of the tax code is the special tax rates that currently apply to gain recognized from the sale of capital assets held for more than a year (long-term). The special tax rates apply to virtually all capital assets including land, improved real estate, your home, and business assets in excess of the accumulated depreciation previously deducted. Beginning in 2008, these special rates, which apply to net long-term capital gains (LTCG)(1) and qualified dividends, drop to zero percent to the extent that your regular tax rate is less than 25% and 15% for all other capital gains. These rates, which apply only to non-corporate taxpayers, also apply for the alternative minimum tax and are available through 2010 barring any future tax law change.
This zero tax rate provides an extraordinary opportunity for a taxpayer to cash in on certain gains and pay no tax. This could be tax paradise for those who carefully plan their transactions this year through 2010. The conventional strategy in the past was to offset as much of your gains as possible with losses from selling other assets in your portfolio. If you have an overall loss, then it is limited to $3,000 ($1,500 for married taxpayers filing separately), and any excess carries over to the next year. Keep in mind that losses from the sale of business assets are generally separately allowed in full in the year of sale, and not mixed with the losses from the sale of other capital assets. So with this change in the law, a new strategy emerges:
it may be more appropriate to take gains to the extent they would be taxed at zero percent.
What this zero tax means to you is that there is no tax on your long-term capital gains to the extent that your regular tax rate is less than 25%. Before you make plans to sell everything in 2008 through 2010, remember that the gain itself adds to your income, impacts income-based limitations, and may possibly push you into a higher regular tax bracket, so it is a balancing act to take advantage of this zero rate. Of course, you can also use losses to offset the gains but contrary to past conventional strategy, you should have enough losses only to keep the gain within the zero tax rate. If your income is too high to take advantage of the zero tax rate, then continue to employ the conventional strategies discussed above for 2008 through 2010.
The zero tax rate applies to the amount of your taxable income below the 25% tax bracket. For 2008, this “breakpoint” is the “top” of the 15% bracket and is:
– $32,550 for single taxpayers and married taxpayers filing separate returns;
– $65,100 for married taxpayers filing joint returns and surviving spouses; and
– $43,650 for heads of households.
Thus, the amount of your adjusted net capital gain taxed at 0% is:
(1) The breakpoint amount for your filing status, minus
(2) Your “other” taxable income (taxable income reduced by adjusted net
capital gain).
The following issues may also come into play when planning your capital gains and losses strategies: (1) Gains from the sale of inherited capital assets are automatically long-term; (2) By election, long-term capital gains can be used to increase the amount of investment income when figuring the investment interest deduction, but then aren’t eligible for the lower capital gain tax rates; (3) Losses from selling personal-use capital assets, such as your home or auto, are not deductible, and (4) You may have short and/or long-term capital losses from a prior year to account for. Also take into consideration how your state taxes capital gains; most do not have a 0% LTCG rate, and many do not have any special rates for capital gains.
Please give our office a call so that we can help you develop a strategy that will suit your unique situation.
(1) Net capital gain is generally the excess of net long-term capital gains over net short-term capital losses, subject to certain netting rules. However, the zero tax rate doesn't apply to collectibles gain or gain taxed on sales of certain small business stock, both taxed at a maximum rate of 28%, or to unrecaptured Sec. 1250 (depreciation) gain, which is taxed at a maximum rate of 25%.
Disposing of Business Assets Without the Tax Bite
Many taxpayers fail to understand the tax ramifications of disposing of personal property such as equipment, furniture and autos used in business and end up with unpleasant surprises at tax time. The tax consequences of disposing of business assets depends upon how the property was used, how long it was owned, and the method of disposition. There are numerous ways of disposing of an asset, so we can give only an overview.
The key to knowing the tax ramifications of dispositions is to understand the tax term “adjusted basis.” Any gain or loss from the disposition of a business asset is measured from adjusted basis. Adjusted basis is generally the cost of the item reduced by any business deductions taken for the item. Let’s say you purchase computer equipment for $1,000 and it is in a class of business property that must be depreciated over five years. You can elect to write
off any portion of the item the first year (within the Sec. 179 expense limitations) and depreciate the balance over five years. If you elected to depreciate the item instead of taking the Sec. 179 expense election, your depreciation deduction would be $200, and your adjusted basis after the first year would be $800 ($1,000 – $200). If you then sold the equipment for $900, you would have a $100 ($900 – $800) taxable gain. Why? Because $100 of your cost was recovered as the depreciation you had previously taken as a deduction. On the other hand, if it was sold for $500, you would have a $300 deductible loss. So, as you can see, you must take into account how much of the cost of the asset has already been written off to determine any subsequent gain or loss.
Favorite and frequently-encountered deductions for taxpayers are non-cash contributions to charity. Although there are some special rules, taxpayers can generally deduct the lesser of cost or fair market value (FMV) of personal items contributed to a charitable organization. For business assets, adjusted basis is substituted for cost. For example, if a taxpayer contributes to charity a desk that was used only for personal purposes and never for business, that had cost $150 and has a FMV of $50, the taxpayer can take a $50 charitable deduction. However, if the desk had been a business asset and its cost had been fully deducted (depreciated), the taxpayer’s charitable deduction would be zero, since the adjusted basis would have been zero and was less than the FMV.
When a business asset is exchanged (traded-in) for a like-kind item,
generally any gain or loss that would have resulted from the sale of the asset increases or decreases the adjusted basis of the replacement
property. Thus, where a sale would result in a gain, the gain can be
avoided by exchanging the item, such as trading in one business vehicle for another. On the other hand, if a sale would result in a loss, it is
probably to the taxpayer’s advantage to actually sell the business asset so a loss can be taken.
Gains and losses from the sale of business assets are not included on the business schedule in the tax return where net profit or loss from operating the business is figured, and generally do not affect the taxpayer’s
self-employment tax. Generally, losses from selling business assets are fully deductible in the year of sale. Gains, to the extent they are
attributable to depreciation, are generally treated as ordinary income (but still not taxable for self-employment tax purposes), and any additional gain is treated as capital gain. If the asset was held for more than a year, the long-term capital gains rates will apply.
At times, you may simply scrap an item because it has no further use in your business and has no resale value. When this happens, treat the disposition as a sale for no money, which will produce a loss equal to the balance of the
adjusted basis at that time. If an item ceases to be used for business purposes and is converted to personal use, your personal basis becomes the adjusted basis at the time of conversion, with no additional deduction for the business. If the item is subsequently disposed of, any amount received in excess of the adjusted basis would be taxable, but any loss would not be deductible.
If you simply give the item away to an individual, neither the business nor you, as an individual taxpayer, is allowed a deduction. The general rule is that the recipient’s basis will be the asset’s adjusted basis at the time of the gift. However, where a sale in the hands of the recipient would result in a loss, the loss would be based on the lower of the item’s adjusted basis or FMV at the time of the gift. If the value of the asset, plus other gifts given to the same individual during the year, exceeds $12,000 (2008), a Gift Tax return generally will be required.
Disposing of personal property business assets can be complicated, so please call us for additional information.
Avoiding the IRS
Audit Net
The IRS recently announced they will be stepping up their tax return audits after several years of heavy reliance on correspondence audits. Their mission is to help fill the tax gap. The areas of increased audits include Schedule Cs (sole proprietor businesses) where the Treasury Department estimates income to be underreported by $68 billion.
An IRS tax audit can come in a number of forms. The most demanding are the face-to-face audits, which require sitting down with an auditor and reconciling income and deductions. Others are the less demanding correspondence audits where the IRS has reason to believe that the taxpayer failed to include reported income or has overstated deductions.
Face-to-Face Audits – Self-employed, high-income taxpayers, those who have omitted substantial income, or those who repeatedly fail to show income to support their lifestyle are more likely to be subject to these types of audits. Some are simply random to provide the IRS with statistics for targeting the most fruitful audit results.
You can appear for the audit yourself, but that is probably a bad idea since you are not trained in the rules and regulations regarding audit procedures and what limits the IRS’s incursion into your private life. You can authorize your tax professional to handle it without you. Often, this is the best way to prevent
the audit from escalating beyond the original areas that attracted the interest of the IRS in the first place. Practitioners experienced with IRS audits are less likely to become emotional or to make statements that would lead to additional IRS questioning.
Correspondence Audits – Employers, banks, lending institutions, schools, brokerage firms, escrow companies and others all feed data to the IRS, which the IRS, in turn, matches by computer to the information reported on your tax return. If there is a significant discrepancy, the IRS will correspond with the taxpayer. Here are some examples of typically-encountered discrepancies:
·
Unreported
Retirement Income – Whenever a taxpayer takes money out of one IRA account and
rolls it over within the 60-day statutory limit into another IRA or qualified
plan, the income is not taxable. The IRS will know about the withdrawal but not
the subsequent rollover, and unless the rollover is reported on the tax return,
the IRS will believe it to be a taxable distribution.
·
Gross
Proceeds of Sale – Generally, when real estate, stock or marketable securities
are sold, the IRS knows what you sold and for what price. Thus, you must account
for the sale on the tax return and compute the gain or loss. If you omit
reporting the transaction, the IRS will treat the entire sales price as profit,
adjust your tax, and notify you via a correspondence audit.
·
Alimony Paid
or Received – A taxpayer who pays alimony is able to deduct the amount he or she
paid. On the other hand, the recipient of that alimony must report that amount
as taxable income. The IRS checks to make sure the amounts match. If they don’t,
expect a notice in the mail.
·
Home
Mortgage Interest – Each of your mortgage lenders will report to the IRS the
interest paid on your mortgage for the year and issue you a Form 1098 for the
same amount. If these amounts don’t reconcile, expect a notice or a request for
an explanation.
·
Tuition Paid
– Because of the education tax credits that can be claimed for paying tuition to
a qualified higher education institution, the IRS requires those institutions to
report the tuition received to the IRS and a Form 1098-T issued to the student.
Thus, the IRS has the ability to verify the tuition paid during the year, and
any mismatch could result in a correspondence audit.
·
Interest and
Dividends – The IRS allows many financial institutions to issue substitute
1099s, i.e., forms that are not in the standard 1099 format. These substitute
forms – with various types of interest and dividends reported separately and
spread throughout lengthy annual account statements – can often be
misinterpreted by an untrained eye. To make matters worse, many brokerage firms
have issued amended 1099 statements late in the tax filing season because of
errors in allocating the investment income by the proper type. Incorrectly
reported, erroneously reported, or omitted investment earnings can trigger
correspondence from the IRS.
· Non-Taxable Interest – Interest from municipal obligations are tax-free for purposes of computing federal tax. However, tax-free municipal interest income is added to income for purposes of computing taxable social security income and determining whether a taxpayer qualifies for earned income credit (EIC). Thus, all tax-free municipal interest must be reported on the tax return or risk a subsequent inquiry from the IRS.
· Cash Contributions Beginning in 2007 – Beginning in the 2007 tax year, regardless of the amount of cash contributed, the contribution must be backed up by either a bank record or written communication from the donee organization showing the: (1) name of the donee organization, (2) date of the contribution, and (3) amount of the contribution. The recordkeeping requirements may not be satisfied by maintaining other written records.
Just because you received a notice, don't assume that the IRS is correct. They are frequently wrong. Contact this office immediately upon receipt of any inquiry from the IRS or state tax agency. Procrastination only leads to further action on the part of the IRS or state agency.
Employers Beware! New Form Available to Misclassified Workers
The Internal Revenue Service has developed a new form for employees who have been misclassified as independent contractors by their employers. Form 8919, Uncollected Social Security and Medicare Tax on Wages, will now be used to figure and report the employee’s share of uncollected Social Security and Medicare taxes due on their compensation.
Generally, a worker who receives a Form 1099 for services provided as an independent contractor must report the income on Schedule C, and pay self-employment tax on the net profit using Schedule SE. However, sometimes the worker is incorrectly treated as an independent contractor by an employer when he or she is actually an employee. When this happens, beginning with tax year 2007, Form 8919 will be used by workers who performed services for an employer but the employer did not withhold the worker’s share of Social Security and Medicare taxes.
In addition, the worker must meet one of several criteria indicating he or she was an employee while performing the services. The criteria include the following:
· The worker was previously treated as an employee by the firm and is performing services in a similar capacity and under similar direction and control.
· The worker’s co-workers are performing similar services under similar direction and control and are treated as employees.
· The worker’s co-workers are performing similar services under similar direction and control and filed Form SS-8 for the firm and received a determination that they were employees.
· The worker has been designated as a Section 530 employee by his or her employer or by the IRS prior to January 1, 1997.
· The worker has filed Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding, and received a determination letter from the IRS stating that he or she is an employee of the firm.
· The worker has received other correspondence from the IRS that states he or she is an employee.
· The worker has filed Form SS-8 with the IRS and has not yet received a reply.
By using Form 8919, the worker’s Social Security and Medicare taxes will be credited to his or her Social Security record. To facilitate this process, the IRS will electronically share Form 8919 data with the Social Security Administration.
A completed Form SS-8 may be filed with the IRS by either the employer or an employee – with or without the knowledge or consent of the other party – to request a determination of the worker’s status as an employee. The IRS will rule with regard only to prior employment status, not on the individual’s prospective employment status as an employee or independent contractor. During the review of the information provided with Form SS-8, enough questions may be raised to result in an employment tax audit of the employer.
If it is determined in audit that the worker should have been treated as an employee and not as an independent contractor, the employer may face some serious, and potentially expensive, consequences. In addition to having to pay the payroll taxes that should have been withheld, the employer must issue the employee a W-2 and revised Form 1099 for the years that are reclassified. The employer will also need to review any of its benefit plans to determine the consequences of the reclassification.
While it may be tempting to classify a worker as an independent contractor to avoid paying the employer’s share of employment taxes, or having to deal with the extra tax filings and paperwork that comes with employees, the consequences of having that person reclassified as an employee can be severe. Now that the IRS has provided employees with a convenient method to pay their share of the Social Security and Medicare taxes, and thus raise the “red flag” as to the classification, it is likely that the IRS will be more aggressive in following through with audits of employers.
For more information, please give this office a call.
Since You Asked
Q
– My daughter, who is my dependent, attends college full-time. My ex-husband
pays all of her tuition. Since I claim her as a dependent, my ex-husband is
unable to claim the tuition credit. Is that correct?
A
- Yes, your ex-husband cannot claim the tuition credit, since it is claimed by
the individual who takes the personal exemption for the student. Thus, if your
daughter was emancipated, not your dependent, and claimed herself on her own tax
return, she would be the one who claims the credit. Good news for you, however.
Since you claim her as a dependent, you are the one that claims the credit even
though you did not pay the tuition.
Q – I purchased a maintenance plan for my office
photocopy machines. The contract is for three years, and I was given a discount
for prepaying the entire cost of the contract up front. After doing this, I was
later told that I might not be able to deduct the entire cost of the contract
this year. Is that true?
A – Unfortunately, that is true. Generally, where an expense relates to a period covering more than 12 months, IRS and most courts agree that the deduction must be spread over the period to which the expense applies. In your case, you’ll need to spread the deduction over the three-year period of the maintenance contract.
Q – My business is organized as an S Corporation, and I’ve heard that there is a new rule related to the above-the-line health insurance deduction for sole owner employees of an S Corporation. Can you explain?
A – In 2006, IRS guidance had concluded that an S corporation's sole shareholder, who was also its sole employee, couldn't buy health insurance in his or her own name and deduct the premiums above-the-line in arriving at adjusted gross income under a special provision that applies for self-employed persons, partners, and more-than-2% shareholder-employees of S corporations. The IRS has since changed its tune, and now allows the deduction if the sole shareholder makes the premium payments and furnishes proof of payment to the corporation, and it then reimburses him or her. The S corporation reports the amount of the premium reimbursements as wages on the shareholder-employee’s Form W-2, and the shareholder-employee reports that amount as gross income on his or her Form 1040. The changed position may make it possible to file an amended return, claiming a refund for someone who was denied a deduction under the old rule.
Q – I am self-employed, and occasionally solicitors for charitable organizations will come into the office looking for a contribution. Can I deduct those contributions as a business expense?
A – Generally, for self-employed individuals, charitable contributions are not deductible on Schedule C as a business expense, and can be deducted only as an itemized deduction on Schedule A. However, tax regulations state that transfers
to a charity that are directly related to a taxpayer's business and made with a “reasonable expectation of financial return commensurate with the amount transferred” may be deductible as a business expense. You should contact this office if you have questionable contributions.