Domestic Production Activities Deduction

 

What is Domestic Production Activities Deduction? 

The Domestic Manufacturing Deduction also referred to as DPAD or the Section 199 deduction is a tax deduction for businesses that perform manufacturing and other qualified production activities in the United States and Puerto Rico [US-based].  It was established in 2004 by the American Jobs Creation Act of 2004 to increase the investment in domestic manufacturing facilities. 

What lines of business qualify for the dedication?

The following lines of business qualify for the Domestic Production Activities Deduction. They MUST be US-based:

• Manufacturing and production
• Selling, leasing, or licensing items that have been manufactured
• Producing or growing agricultural or horticultural products
• Marketing US-based agricultural or horticultural products
• Mineral extraction
• Oil-related production activities.  This includes production, refining, processing, transportation, or distribution of oil or gas, or any primary product from oil or gas
• Production of electricity or water
• Qualified film production
• Selling, leasing, or licensing motion pictures that have been produced in the United States,
• Construction services including building and renovation of residential and commercial properties
• Engineering and architectural services
• Software development, including the development of video games.

The following activities do not qualify

·        Sale of food and beverages prepared by the taxpayer at a retail establishmen

·        Transmission or distribution of electricity, natural gas, or potable water

·        The lease, rental, license, sale, exchange, or other disposition of land.

·        Construction services those are cosmetic in nature, such as painting

·        Leasing or licensing items to a related part

What entities qualify for the dedication?

·        Corporations, both “C” and “S” corporation

·        Partnerships and Limited Liability companies

·        Sole Proprietorships

·        Agricultural Cooperatives

What are the tax savings? 

The tax savings is a tax deduction equaling to the lesser of

·        Nine percent of NET Qualified Production Income

·        Nine percent of taxable income, without regard the DPAD

Also, the deduction cannot exceed fifty percent of W-2 wages and reportable commission paid to employees that contribute to the qualified activities.

Qualified Production income is the net of gross income from the qualified production activities less all expenses directly related to the qualified production activities.  For a business with only one line of business, the expensed deducted will be the same as total expenses. For businesses with multiple lines of business, income and expenses will need to be allocated.

General Rules and Safe Harbor

The Domestic Production Activities Deduction is limited to income arising from qualified production actives in whole or significant part US-based. Under a "safe harbor" rule, businesses can take the deduction if at least twenty percent of the total costs are the result of direct labor and overhead costs from US-based operations.

If any part of manufacturing or production activities is outside the United States and Puerto Rico, then businesses must use either the safe harbor rule or allocate costs using the facts and circumstances of their business.

Cautions

The DPAD is considered a Tier 1 audit issue by the IRS and requires additional due diligence to ensure compliance and substantiation of company practices.  Tier I audit issues are of “high strategic importance” to the IRS and have a significant impact on one or more industries. Tier I issues may involve a large number of taxpayers, a significant dollar amount, a substantial compliance risk or high visibility. Issues will be placed in this category if the IRS has an established legal position or directive out on the issue.  In other words, if you take the DPAD, it could be a “red flag” for audit.  Normally if a taxpayer is honest and follows the rules, with transparency, an audit should not deter them from taking appropriate tax deductions.  The DPAD rules are complex and time consuming, if the deduction is calculated incorrectly or lacks substantiation, your business could face additional taxes, penalties, and interest.  Thus it is imperative that you seek proper tax advice from a CPA or tax attorney.

Applicable tax codes 

(1)   Internal Revenue Code § 199

(2)   Internal Revenue Code § 927(a)(2)(C)

(3)   Internal Revenue Code § 1382(b)(c)

(4)   IRS Regulation § 1.199

(5)   IRS Proposed Regulation § 1.199(3)(f)(3)

(6)   IRS Instructions for Form 8903

Summary 

Many small business’s has traditionally over looked a potential this very important tax deduction.  Even though there are a set of complex rules, at nine percent of NET income from qualified production activities, businesses are unnecessary leaving money on the table by not taking advantage this tax deduction.  According to Paul Schlather, a senior tax partner with PricewaterhouseCoopers' Private Company Services practice, “while Section 199 comes with a very complex set of rules, chances are small businesses will qualify for the deduction much easier than the rules depict".

 

GET CREDIT FOR GENERATING YOUR OWN HOME POWER

Through 2016, taxpayers can get a 30% tax credit on their federal tax returns for installing certain power-generating systems in their homes. The credit is non-refundable, which means it can only be used to offset a taxpayer’s current tax liability, but any excess can be carried forward to offset tax through 2016.

Systems that qualify for the credit include:

·    Solar water-heating system - Qualifies if used in a dwelling unit used by the taxpayer as a main or second residence where at least half of the energy used by the property for such purposes is derived from the sun. Heating water for swimming pools or hot tubs does not qualify for the credit. The property must be certified for performance by the Solar Rating Certification Corporation or a comparable entity endorsed by the state government where the property is installed.

·    Solar electric system - Qualified system that uses solar energy to generate electricity for use in a dwelling unit located in the U.S. and used as a main or second residence by the taxpayer.

·    Fuel cell plant - This is a fuel cell power plant installed in the taxpayer’s principal residence that converts a fuel into electricity using electrochemical means. It must have an electricity-only generation efficiency of greater than 30% and generate at least 0.5 kilowatt of electricity. The credit is 30% of qualified fuel cell expenditures but limited to $500 for each 0.5 kilowatt of the fuel cell property’s capacity to produce electricity.

·    Qualified small wind energy - A wind turbine used to generate electricity for use in connection with a dwelling unit used as a main or second residence by the taxpayer

·    Qualified geothermal heat pump - Must use the ground or ground water as a thermal energy source to heat the dwelling unit or as a thermal energy sink to cool the dwelling unit, and must meet the Energy Star program requirements in effect when the expenditure is made. The dwelling unit must be used as a main or second residence by the taxpayer.

 

Other aspects of the credit:

·    Limited carryover - The credit is a non-refundable personal credit, which limits the credit to the taxpayer’s tax liability for the year. However, the portion of the credit that is not allowed because of this limitation may be carried to the next tax year and added to the credit allowable for that year. Thus, the credit carryover is available through 2016 (the final year for the credit).

·    Installation costs - Expenditures for labor costs allocable to onsite preparation, assembly, or original installation of property eligible for the credit, as well as for piping or wiring connecting the property to the residence, are expenditures that qualify for the credit.

·    Swimming pool - Expenditures that are for heating a swimming pool or hot tub are not taken into account for purposes of the credit.

·    Newly constructed homes - The credit can be taken for newly constructed homes if the costs of the residential energy-efficient property can be separated from the home construction and the required certification documents are available.

Certification - A taxpayer may rely on a manufacturer's certification that a product is a Qualified Energy Property. A taxpayer is not required to attach the certification statement to the return on which the credit is claimed. However, taxpayers are required to retain the certification statement as part of their records. The certification statement provided by the manufacturer may be a written copy of the statement that is posted on the manufacturer’s website with the product packaging details in printable form or in any other manner that will permit the taxpayer to retain the certification statement for tax recordkeeping purposes.

Installation costs - Costs for labor allocable to onsite preparation, assembly, or original installation of the residential energy-efficient property are includible.

If you have questions about how you can benefit from this credit, please give this office a call.

Documenting Charitable Contributions

In recent years Congress has passed stringent recordkeeping rules for charitable contributions and harsh penalties fir understating taxable income.  The following recordkeeping rules, though not all-inclusive, should be a good guideline.  .

Cash Contributions - Cash contributions include those paid by cash, check, electronic funds transfer, or credit card (see special requirements for payroll cash contributions). You cannot deduct a cash contribution, regardless of the amount, unless you can document the contribution in one of the following ways.

1. A bank record that shows the name of the qualified organization, the date of the contribution, and the amount of the contribution. Bank records may include:

(a)  A canceled check

(b)  A bank or credit union statement, or

(c’)  A credit card statement.

2. A receipt (or a letter or other written communication) from the qualified organization showing the name of the organization, the date of the contribution, and the amount of the contribution.

As a result, if you drop cash into a church collection plate each week at a worship service, you cannot legally deduct that donation on your tax return. The same goes for dropping a cash donation into the Christmas kettle. Instead, you should write a check to the charitable organization of your choice and put the check into the collection plate, or make other arrangements with the organization for giving your tax-deductible contribution to ensure that a bank record, receipt, or letter is provided.

Payroll Contributions - For contributions made by payroll deduction, you must keep:

1. A pay stub, W-2 form, or other document provided by your employer that shows the date and amount of the contribution, and
2. A pledge card or other document prepared by or for the organization to which you are donating that shows the name of this organization. If the employer withheld $250 or more from a single paycheck, the pledge card or other document must state that the organization does not provide goods or services in return for any contribution made to it by payroll deduction. A single pledge card may be kept for all contributions made by payroll deduction, regardless of the amount, as long as it contains all of the required information.

If the pay stub, W-2 form, pledge card, or other document does not show the date of the contribution, you must also have another document that does show the date of the contribution. If the pay stub, W-2 form, pledge card, or other document does show the date of the contribution, you need not keep any other records except those described in (A) and (B).

Non-Cash Contributions - Non-cash contributions include the donation of property, such as used clothing or furniture, to a qualified charitable organization.

Deductions of Less than $250 - If you claim a non-cash contribution of less than $250, you must get and keep a receipt from the charitable organization showing:

1. The name of the charitable organization,
2. The date and location of the charitable contribution, and
3. A reasonably detailed description of the property that was donated.

 

You are not required to have a receipt if it is impractical to get one (for example, if the property was left at a charity’s unattended drop site). However, you still must document the contribution as described above.

Deductions of at Least $250 but Not More than $500 - If you claim a deduction of at least $250 but not more than $500 for a non-cash charitable contribution, you must have and keep an acknowledgment of the contribution from the qualified organization. If the contributions were made in more than one donation of $250 or more, you must have either a separate acknowledgment for each or one acknowledgment that shows the total contribution. The acknowledgment(s) must be written and should include the following:

1. The name of the charitable organization,
2. The date and location of the charitable contribution,
3. A reasonably detailed description (but not necessarily the value) of any property contributed,
4. Whether or not the qualified organization gave you any goods or services as a result of the contribution (other than certain token items and membership benefits), and
5. If goods and/or services were provided to you, the acknowledgement must include a description and good faith estimate of the value of those goods or services. If the only benefit received was an intangible religious benefit (such as admission to a religious ceremony) that generally is not sold in a commercial transaction outside the donative context, the acknowledgment must say so and does not need to describe or estimate the value of the benefit.

Deductions of over $500 but Not over $5,000 - If you claim a deduction of over $500 but not over $5,000 for a non-cash charitable contribution, you must get and keep the same acknowledgement and written records as for contributions of at least $250 but not more than $500 (as described above).

In addition, the records must also include:

1. How the property was obtained (for example, by purchase, gift, bequest, inheritance, or exchange).
2. The approximate date the property was obtained or, if you created, produced, or manufactured the item, the approximate date the property was substantially completed.
3. The cost or other basis, and any adjustments to the basis, of property held for less than 12 months and, if available, the cost or other basis of property held for 12 months or more. This requirement, however, does not apply to publicly-traded securities. If you are not able to provide information on either the date the property was obtained or the cost basis of the property, and there is reasonable cause for not being able to provide this information, a statement of explanation must be attached to the return.

Deductions over $5,000 - Because of special rules related to contributions over $5,000, please call this office for documentation requirements of the particular contribution before making the contribution.

Out-of-Pocket Expenses - If you render services to a qualified organization and have unreimbursed out-of-pocket expenses related to those services, the following three rules apply.

1. You must have adequate records to prove the amount of the expenses.
2. You must get an acknowledgment from the qualified organization that contains:
a. A description of the services provided,
b. A statement of whether or not the organization provided you with any goods or services to reimburse you for the expenses incurred,
c. A description and good faith estimate of the value of any goods or services (other than intangible religious benefits) provided as reimbursement, and
d. A statement that the only benefit received was an intangible religious benefit, if that was the case. The acknowledgment does not need to describe or estimate the value of an intangible religious benefit.

3. The acknowledgement must be obtained before the earlier of the following:
a. The date of filing the return for the year in which the contribution was made, or
b. The due date, including extensions, for the return.

Car Expenses - When you claim expenses directly related to the use of your car to provide services to a qualified organization, you must keep reliable written records. Whether the records are considered reliable depends on the facts and circumstances. Generally, your records will likely be considered reliable if made regularly and/or near the time the expense was incurred. The records must show the name of the organization being served and the date each time the car was used for a charitable purpose. If the standard mileage rate of 14 cents per mile is used, the records must show the miles driven for the charitable purpose.

If you deduct actual expenses, the records must show the costs of operating the car that are directly related to a charitable purpose. General repairs and maintenance expenses, depreciation, registration fees, or the costs of tires or insurance cannot be deducted.

Vehicle Donations - When the deduction claimed for a donated vehicle exceeds $500, IRS Form 1098-C (or another statement containing the same information as Form 1098-C) furnished by the charitable organization must be attached to your filed tax return. Without the 1098-C or other statement, no deduction is allowed. When the charity sells the vehicle, Form 1098-C (or other statement) must be obtained within 30 days of the sale of the vehicle.

CAUTION: With the exception of vehicle contributions, charitable gift acknowledgements must be obtained before the earlier of the following:

1. The date on which your return was filed for the year in which you made the contribution, or
2. The due date, including extensions, for filing the return.

If you have questions regarding charitable recordkeeping or what is deductible as a charitable contribution, please give our office a call.

SUPREME COURT’S DOMA RULING HAS IMPORTANT TAX IMPLICATIONS

Some of the implications of the Supreme Court’s DOMA ruling are obvious, while others are not.  For starters, same-sex married couples will now be able to make decisions regarding filing a joint return that were previously denied them.  In an odd way this is going to bring equality in the tax code.  Before the court’s ruling, a same sex couple was required to file single, however in tax resolution cases when one person owes back taxes, the IRS treated the couple as married if they lived in community property states like California.  The ability to pay by the delinquent partner was increased by 50% of the income and assets of the other partner

The distinction between married and unmarried status is pervasive in federal tax law, even though the code does not define such terms as husband, wife or married.  The issue comes into play in connection with income tax rates, the treatment of capital losses, credits for the elderly and disabled, taxation of Social Security benefits, and a number of other provisions.

Marital status also plays a key role in the estate and gift tax laws and in the part of the tax code dealing with taxation on the sale of property.  For estate tax purposes, property transferred to one spouse as the result of the death of another spouse is deductible for purposes of determining the value of the decedent’s estate.  In the case heard by the court, U.S. v. Windsor, Windsor owed more than $363,000 in federal estate tax on her wife’s estate, since she was not covered by the spousal deduction. She would have owed zero estate tax with the benefit of the spousal deduction.

Moreover, gifts from one spouse to another are deductible for purposes of the gift tax, and gifts from one spouse to a third party are deemed to be from both spouses equally. Transfers of property from one spouse to another or to a former spouse if the transfer is incident to a divorce are permitted without any recognition of gain or loss. These provisions permit married couples to transfer substantial sums to one another, and to third parties, without tax liability in circumstances in which single taxpayers would not enjoy the same privilege. 

Another implication is the IRS will have their hands full processing mountains of amended tax returns; amending returns from same sex couples who originally filed single.

 

Read This Before Tossing Old Tax Records

Now that your taxes have been completed for 2012, you are probably wondering what old records can be discarded. If you are like most taxpayers, you have records from years ago that you are afraid to throw away. It would be helpful to understand why the records must be kept in the first place.

Generally, we keep tax records for two basic reasons: (1) in case the IRS or a state agency decides to question the information reported on our tax returns, and (2) to keep track of the tax basis of our capital assets so that the tax liability can be minimized when we dispose of them.

With certain exceptions, the statute for assessing additional taxes [Statute of Limitations] is three years for the IRS and four years for the state from the return due date or the date the return was filed, whichever is later. In addition the federal three-year Statute of Limitation is extended to six years if a taxpayer omits more than 25 percent of the income reported on a tax return. And, of course, the statutes don't begin running until a return has been filed. There is no limit where a taxpayer files a false or fraudulent return to evade taxes.

If an exception does not apply to you, for federal purposes, most of your tax records that are more than four years old can probably be discarded.

Example - Sue filed her 2009 tax return before the due date of April 15, 2010. She will be able to dispose of most of the 2009 records safely after April 15, 2014. On the other hand, Don files his 2009 return on June 2, 2010. He needs to keep his records at least until June 2, 2014. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

The big problem! The problem with the carte blanche discarding records for a particular year because the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. These need to be separated and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into that category:

·     Stock acquisition data - If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed to prove the amount of profit (or loss) you had on the sale.

·     Stock and mutual fund statements (If you reinvest dividends) - Many taxpayers use the dividends they receive from stocks or mutual funds to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gain when it is finally sold. Keep statements at least four years after the final sale.

·    Tangible property purchase and improvement records - Keep records of home, investment, rental property, or business property acquisitions AND a related capital improvement for at least four years after the underlying property is sold.

For example, when the large $250,000 and $500,000 home exclusion was passed into law several years back, homeowners became lax in maintaining home improvement records, thinking the large exclusions would cover any potential appreciation in the home's value. Now that the exclusion may not always be enough, records of home improvements are vital. Records can be important, so please use caution when discarding them.

If you have questions about whether or not to retain certain records? Give this office a call first; it is better to make sure, before discarding something that might be needed down the road.

Tax Tips for Recently Married Taxpayers

If you got married during 2012, here are some post-marriage tips to help you avoid stress at tax time.

1. Notify the Social Security Administration − Report any name change to the Social Security Administration so that your name and SSN will match when filing your next tax return. Informing the SSA of a name change is quite simple. File a Form SS-5, Application for a Social Security Card at your local SSA office. The form is available on SSA's Web site, by calling 800-772-1213, or at local offices. Your income tax refund may be delayed if it is discovered your name and SSN don't match at the time your return is filed.
2. Notify the IRS - If you have a new address, you should notify the IRS by sending Form 8822, Change of Address.
3. Notify the U.S. Postal Service - You should also notify the U.S. Postal Service when you move so that any IRS or state tax agency correspondence can be forwarded.
4. Review Your Withholding and Estimated Tax Payments - If both you and your new spouse work, your combined income may place you in a higher tax bracket, and you may have an unpleasant surprise when we prepare your return for 2012. On the other hand, if only one works, filing jointly with your new spouse can provide a significant tax benefit, enabling you to reduce your withholding or estimated payments. The fat is in the fire for 2012, but it may be appropriate to review your withholding (W-4 status) and estimated tax payments, if any, for 2013 to make sure you are not going to be under-withheld and set yourself up to receive bad news.

If you have any questions, please give this office a call.

CONGRESS LEAVES US HANGING AGAIN ON THE AMT

Here it is, almost the end of the year, and as they have done for several years, Congress has not indicated if they will extend the higher AMT exemption amounts or allow them to revert to lower amounts that were in effect before exemptions were increased to shield the middle class from the punitive tax. A recent Congressional report indicates that, if Congress does not extend the AMT break, one in five taxpayers will be impacted by the AMT in 2012.

Originally conceived to combat taxpayers in the higher-income brackets who utilized legal tax shelters and tax preferences to avoid paying income tax, the AMT can be tricky and hit you when least expected. The tax was supposed to inflict a “minimum” tax on those who were able to avoid the regular tax. However, years of inflation have pushed many middle-income taxpayers into the reach of the AMT. Although there is a long list of items that can trigger the AMT, for most individuals, the triggers include the following or a combination of the items listed below:

·      Preference income from exercising stock options from an employer's qualified plan, sometimes referred to as incentive stock options (ISOs);

·      Having large itemized tax deductions;

·      Having large miscellaneous itemized deductions;

·      Large itemized deductions for state income or sales tax, real property tax and personal property tax;

·      Large medical itemized tax deductions;

·      Home equity debt interest deduction; and

·      Interest income from private activity bonds.

Because of its unintended impact on the middle class, Congress has been promising AMT reform. In the meantime, annually increasing the amount of income exempted from AMT has been their temporary fix, and what that amount will be for 2012 is what Congress has yet to decide. Complicating the issue is that the AMT as it is currently structured provides a significant amount of tax revenue that Congress is reluctant to concede without a replacement. Most analysts have been predicting the higher exemptions will be extended for 2012, and possibly into 2013. But you never know, and we will have to wait and see.

There are planning techniques that can be used to avoid or mitigate the effects of the AMT. If you anticipate an AMT problem this year, it may be appropriate for you to make an appointment to see if there are any steps that can be taken to alleviate the effects of the AMT in your specific tax situation.

Gifting Consequences to Think About

 

Frequently, taxpayers think that gifts of cash, securities, or other assets they give to other individuals are tax-deductible and, in turn, the gift recipient sometimes thinks income tax must be paid on the gift received. Nothing is further from the truth. To fully understand the ramifications of gifting, one needs to realize that gift tax laws are interrelated with estate tax laws.

When a taxpayer dies, his or her gross estate (to the extent it exceeds the excludable amount for the year) is subject to estate taxes. The exclusion for taxpayers dying in 2012 is $5.12 million. In addition, there is an unlimited spousal deduction for married couples. The amounts in excess of these exclusions are subject to inheritance taxes as high as 35%. Naturally, individuals want to do whatever they can to maximize the inheritance to their beneficiaries and limit the amount of inheritance tax on the estate. Since giving away one's assets before he/she dies reduces the individual's gross estate, the government has placed limits on gifts, and if those gifts exceed the limit, they are subject to gift tax that must be paid by the giver.

Gift Tax Exclusions – Certain gifts are excluded from the gift tax.

·  Annual Exclusion – This is the annual amount that an individual can give to any number of recipients. This amount is adjusted for inflation, and for 2012, it is $13,000 (increases to $14,000 in 2013). For example, a taxpayer with five children can give $13,000 to each child in 2012 without any gift tax consequences or the need to file a gift tax return. This amount includes all gifts made to the individual during the year, including birthday, holiday, and special occasion presents, as well as one-time gifts of money or property. The taxpayer cannot deduct the gifts, and the gifts are not taxable to the recipients. Generally, for a gift to qualify for the annual exclusion, it must be a gift of a “present interest.” That is, the recipient's enjoyment of the gift can't be postponed into the future. There is an exception to the present interest rule where the recipient is a minor and the terms of a trust provide that the income and property may be spent by or for the minor before the minor reaches the age of 21, with the balance going to the child at age 21. This allows parents to set assets aside for future distribution to their children while taking advantage of the annual exclusion in the year the trust is set up.

·  Lifetime Limit - In addition to the annual amounts, taxpayers can use a portion of the federal estate tax exemption (it is actually in the form of a credit) to offset an additional $5.12 million during their lifetime without gift tax consequences. Note that the $5.12 million is for 2012 and is expected to be substantially lower once Congress decides upon the 2013 rates. However, to the extent this credit is used against a gift tax liability, it reduces the credit available for use against the federal estate tax at the taxpayer's death.

·  Education & Medical Exclusion - In addition to the two dollar limitation amounts listed above, there are two other types of gifts that can be excluded from the gift tax, regardless of the amount given:

(1) Amounts paid by one individual on behalf of another individual directly to a qualifying educational organization as tuition for that other individual.

(2) Amounts paid by one individual on behalf of another individual directly to a provider of medical care as payment for that medical care. Payments for medical insurance qualify for this exclusion.

Gifts of Capital Assets – Sometimes a gift might be in the form of securities, real estate, or other items that have appreciated in value. In these situations, the gift value is the item's fair market value at the time of the gift. However, when the recipient of the gift sells that asset, he or she will measure his or her gain from the giver's tax basis. For example, a parent gifts 100 shares of XYZ, Inc., worth $9,000 to his or her child. If the parent originally paid $5,000 for the shares and if the child sold the shares for $9,000, the child (the recipient) would be liable for the tax on the $4,000 gain. In effect, the parent (giver) transferred the taxable gain in the stock to the child. This can be beneficial from a tax standpoint if the child is in a lower tax bracket than the parent and isn't subject to the “kiddie tax” rules that tax the child's income at the parent's tax rate.

Gift-Splitting by Married Taxpayers - If the gift-giver is married and both spouses are in agreement, gifts to recipients made during a year can be treated as split between the husband and wife, even if the cash or property gift was made by only one of them. Thus, by using this technique, a married couple can give $26,000 in 2012 to each recipient under the annual limitation discussed previously.

If you have additional questions or would like this office to assist you in planning an appropriate gifting strategy, please give us a call.

Fine-Tuning Capital Gains and Losses

The year's end has historically been a good time to plan tax savings by carefully structuring capital gains and losses. Let's consider some possibilities.

If there are losses to date - As an example, suppose the stocks and other capital assets that were sold during the year result in a net loss and that there are other investment assets still owned by the taxpayer that have appreciated in value. Consideration should be given to whether any of the appreciated assets should be sold (if their value has peaked), thereby offsetting those gains with pre-existing losses.

Long-term capital losses offset long-term capital gains before they offset short-term capital gains. Similarly, short-term capital losses offset short-term capital gains before they offset long-term capital gains. Keep in mind that taxpayers may use up to $3,000 of total capital losses in excess of total capital gains as a deduction against ordinary income in computing adjusted gross income (AGI). Individuals are subject to tax at a rate as high as 35% on short-term capital gains and ordinary income. But long-term capital gains are generally taxed at a maximum rate of 15%.

All of this means that having long-term capital losses offsetting long-term capital gains should be avoided, since those losses will be more valuable if they are used to offset short-term capital gains or ordinary income. Avoiding this requires making sure that the long-term capital losses are not taken in the same year as the long-term capital gains. However, this is not just a tax issue; investment factors also need to be considered. It would not be wise to defer recognizing gain until the following year if there is too much risk that the property's value will decline before it can be sold. Similarly, one wouldn't want to risk increasing a loss on property that is expected to continue declining in value by deferring its sale until the following year.

To the extent that taking long-term capital losses in a different year than long-term capital gains is consistent with good investment planning, a taxpayer should take steps to prevent those losses from offsetting those gains.

If there are no net capital losses so far for the year - If a taxpayer expects to realize such losses in the subsequent year well in excess of the $3,000 ceiling, consider shifting some of the sales and resulting excess losses into the current year. That way, the losses can offset current year gains, and up to $3,000 of any excess loss will become deductible against ordinary income in the subsequent year.

For the reasons outlined above, paper losses or gains on stocks may be worth recognizing (i.e., selling the stock) this year in some situations. But if the stock is sold at a loss with the idea to repurchase it, the repurchase cannot be within a 61-day period (30 days before or 30 days after the date of sale) under the “wash sale” rules. If it is, the loss will not be recognized and will simply adjust the tax basis of the reacquired stock.

Careful handling of capital gains and losses can save substantial amounts of tax. Please contact this office to discuss year-end planning strategies that apply to your particular situation so as to maximize tax savings.

YOUR PENSION PLAN - SMALL CHANGES FOR 2011

In 2011, dollar limitations for pension plans and other retirement-related items will either remain unchanged, or the inflation adjustments for 2011 will be small. Check out what to expect in the new year....

• The contribution limit for employees who participate in section 401(k), 403(b), or 457(b) plans, and the federal government's Thrift Savings Plan, remains unchanged, at $16,500.
• The catch-up contribution limit in those plans for those aged 50 and over remains unchanged, at $5,500.
• The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are active participants in an employer-sponsored retirement plan and have modified adjusted gross incomes (AGI) between $56,000 and $66,000, unchanged from 2010.
For married couples filing jointly, in which the spouse who makes the IRA contribution is an active participant in an employer-sponsored retirement plan, the income phase-out range is $90,000 to $110,000, up from $89,000 to $109,000. For an IRA contributor who is not an active participant in an employer-sponsored retirement plan and is married to someone who is an active participant, the deduction is phased out if the couple's income is between $169,000 and $179,000, up from $167,000 and $177,000.
• The AGI phase-out range for taxpayers making contributions to a Roth IRA is $169,000 to 179,000 for married couples filing jointly, up from $167,000 to $177,000 in 2010. For singles and heads of household, the income phase-out range is $107,000 to $122,000, up from $105,000 to $120,000. For a married individual filing a separate return who is an active participant in an employer-sponsored retirement plan, the phase-out range remains $0 to $10,000.
• The AGI limit for the saver's credit (also known as the retirement savings contributions credit) for low- and moderate-income workers is $56,500 for married couples filing jointly, up from $55,500 in 2010; $42,375 for heads of household, up from $41,625; and $28,250 for married individuals filing separately and for singles, up from $27,750.

Questions?
Call us at 562-912-4334 for more information.

Please note, to comply with IRS regulations, we need to advise that any discussion of federal tax issues in this blog is not intended or written to be used, and cannot be used by you, (i) to avoid any penalties imposed under the Internal Revenue Code or (ii) to promote, market or recommend to another party any transaction or matter addressed herein. For more information please go to http://www.lw.com/docs/irs.pdf

DECEMBER 2010 TAX BRIEFING

401(k) Distribution to Disabled Spouse:
In the Fall 2010 edition of the Retirement News for Employers , the IRS stated that a distributable event in a 401(k) plan includes an employee's disability, but not a spouse's or dependent's disability. However, the 401(k) plan may allow a hardship distribution based on an immediate and heavy financial need of the employee or the employee's spouse, dependents, or beneficiaries. The distribution can be no more than necessary to satisfy the financial need, but can include amounts needed to pay taxes resulting from the distribution. The plan's terms will define "immediate and heavy financial need,"which may cover disability-related medical expenses for the employee's spouse.

Real Estate Dealer or Investor:
The Tax Court held that a couple who bought and sold real estate recognized ordinary income instead of capital gains. In finding that the real estate transactions were conducted in the ordinary course of a trade or business and not for investment, the Tax Court noted that (1) taxpayers' objective in purchasing and selling real estate was to recognize the maximum gain within a short period (most sales occurred within four months after they purchased the property); (2) the real estate transactions were entered into regularly and resulted in significant gains; (3) taxpayers engaged in at least 15 sales over three years, and (4) they did not rely on the services of a real estate agent or broker to select, promote, or sell their properties. Wendell Garrison , TC Memo 2010-261 (Tax Ct).

Copyright © 2010 Thomson Reuters/PPC. All rights reserved.
________________________________________

SOULD YOU FILE A TAX RETURN?

Do you ever wonder whether your income is high enough to warrant the filing of a tax return? Because the minimum income level varies depending on filing status, age, and the type of income you receive, it can be a bit complicated.
Use the following guide to determine whether you must file a federal income tax return for 2010.

Single Taxpayers
If you expect to file a single return, the IRS requires you to file a return for 2010 if your gross income for the year is at least $9,350 if you are under age 65 and $10,750 if you are 65 or older.

Married Filing Jointly
For married persons filing jointly, you are required to file a return if gross income for 2010 is at least $18,700 if both of you are under age 65. If one of you was at least age 65 in 2010, the limit is $19,850 - and if both of you were 65 or over, you must file if you made at least $20,900.

If you are not living with your spouse at the end of the year or you weren't living with them on the day they passed away, the IRS requires you to file a return if your gross income is at least $3,650. Each personal exemption in 2010 is worth $3,650.
For married persons filing a separate return, no matter what age, you must file a return if gross income is at least $3,650.

Head of Household
For persons filing as head of household, you must file a return for 2010 if gross income is at least $12,000 if under age 65 and $13,400 if at least age 65.

Qualifying Widow or Widower
For persons filing as a qualifying widow or widower with a dependent child, you must file a return for 2010 if gross income is at least $15,050 if under age 65 and $16,150 if at least age 65.

Other Situations That Require Filing
Even if you don't earn this much income, other situations necessitate filing a tax return. For example, a dependent has to file a return for 2010 if they received more than $950 in unearned income or more than $5,700 in earned income.

Other situations include:
You Owe Certain Taxes. If you owe FICA or Medicare taxes (also called payroll taxes) on unreported tips or other reported income that were not collected, you must file a return. You must also file a tax return if you are liable for any alternative minimum tax. Finally, you must file a return if you owe taxes on individual retirement accounts, Archer MSA accounts, or an employer-sponsored retirement plan.

Advance Earned Income Tax Credit Payments. The Earned Income Tax Credit is a federal income tax credit for eligible low-income workers. The credit reduces the amount of tax an individual owes, which may be returned in the form of a refund. If you receive advance payments for the earned income credit from your employer, you must file a return.

Self-Employment Earnings. If your net earnings from self-employment are $400 or more, you must file a return.

Church Income. If you earn employee income of at least $108.28 from either a church or a qualified church-controlled organization that is exempt from employer-paid FICA and Medicare taxes, you must file a return.

Questions?
Call us at 562-912-4334 for more information about filing requirements and your eligibility to receive tax credits.

Please note, to comply with IRS regulations, we need to advise that any discussion of federal tax issues in this blog is not intended or written to be used, and cannot be used by you, (i) to avoid any penalties imposed under the Internal Revenue Code or (ii) to promote, market or recommend to another party any transaction or matter addressed herein. For more information please go to http://www.lw.com/docs/irs.pdf

How the Bush Tax Cuts Affect Tax-Saving Strategies

Each November, we like to look at the steps you can take to reduce your tax bill. This year, it's a little ambiguous, because the Bush tax cuts and credits are set to expire at the end of 2010. If they do expire, a lot of folks will experience a significant adjustment to their tax situation.

The "Bush tax cuts" refers to legislation enacted in 2001 and 2003. The cuts lowered tax rates on income, dividends, and capital gains; eliminated the estate tax; lowered burdens on married couples, parents, and the working poor; and increased tax credits for education and retirement savings.

Both Republicans and Democrats favor an extension of the tax cuts for the middle class. Where they differ is whether to extend the cuts for Americans in the top 2% of taxpayers.

With this in mind, we're looking at year-end measures separately for these two groups: the middle class - those making less than $200,000 for singles / $250,000 for married filers - and the higher income taxpayers - those making more than $200,000 / $250,000.

But first, let's take a quick look at what's at stake.

If All the Bush Tax Cuts Expire...
Among other things, if the Bush tax cuts were allowed to expire, the following would take place:
1. Tax brackets would change, from 10%, 15%, 25%, 28%, 33%, and 35% to 15%, 28%, 31%, 36%, and 39.6%.
2. Long-term capital gain tax rates would rise from 15% to a maximum of 20%.
3. The child tax credit would be lowered.
4. The alternative minimum tax would cease to be indexed for inflation.
5. The marriage penalty would be reinstated.

Middle-Income Taxpayers
We don't expect Congress to allow the tax cuts to expire for this group. That means middle-income taxpayers can take the same measures this year they have in previous years to reduce their tax burden for 2010.

We recommend the following steps to save on taxes this year: defer income, accelerate your deductions, and plan out your capital gains.

Defer Income
If you are planning to sell an investment on which you have a gain, it may be best to wait until the new year. This will defer payment of the taxes for another year (subject to estimated tax requirements).
• If you are due a bonus at year-end, you may be able to defer receipt of these funds until January. Again, this can defer the payment of taxes (other than the portion withheld) for another year. (Note that deferral of tax generally won't work where the bonus is contractually due in 2010.)
• If your company grants stock options, it may be wise to wait until next year to exercise the option or sell stock acquired by the exercise of an option. (Exercise of the option is often a taxable event; sale of the stock is almost always a taxable event.)
• If you're self-employed, and you can afford the delay in cash inflow, defer sending invoices to clients until the end of December.

Accelerate Deductions
Pay a state estimated tax installment in December instead of at the January due date. Just make sure the payment is based on a reasonable estimate of your state tax.
• Pay your entire property tax bill, including installments due in 2011, by year-end. (This is not applicable to mortgage escrow accounts.)
• Try to bunch threshold expenses, such as medical expenses and miscellaneous itemized deductions. (Threshold expenses are deductible only to the extent they exceed a certain percentage of adjusted gross income.) By bunching these expenses into one year, rather than spreading them out over two years, you have a better chance of exceeding the thresholds, thereby maximizing your deduction. For example, you might pay medical bills and dues and subscriptions in whichever year they would do you the most tax good.

Caution: In most cases, credit card charges are considered paid in the year of the charge regardless of when you pay on the card. But this does not apply to store revolving credit cards. If you charge expenses on a Wal-Mart store credit card, for example, the deduction cannot be claimed until the bill is paid.

Some tax benefits are phased out if you have more than a certain level of adjusted gross income. In these cases, a strategy of deferring income and accelerating deductions may also allow you to claim larger deductions, credits, and other tax breaks for 2010.

Tip: Deferring income into 2011 is an especially good idea for taxpayers who anticipate being in a lower tax bracket next year, either because of much-reduced income or much-increased deductible expenses.

Minimize Taxes on Investments
Judiciously match your capital gains and losses to reduce your tax burden for 2010. Where appropriate, try to avoid short-term gains, which are usually taxed at a much higher tax rate (up to 35%) than long-term gains (15%). You might consider, where feasible, trying to reduce all capital gains and generate short-term capital losses of up to $3,000.

Tip: If you have a large capital gain this year, consider selling an investment on which you have an accumulated loss. Capital losses are deductible up to the amount of your capital gains plus $3,000.

High-Income Taxpayers
Depending on what Congress decides in this legislative session, individuals making more than $200,000 filing singly or $250,000 filing married in 2010 will owe more tax than they have since the 2001 Bush tax cuts were passed. What does this mean for end-of-year tax planning?

Don't Defer Income
If tax cuts for the richest Americans are allowed to expire at the end of the year, then many in the current 33% tax bracket will find themselves in the 36% bracket, and those currently taxed at the 36% rate will be taxed at 39.6%.

For these taxpayers, it makes sense to bump up 2010 income, to take advantage of the current lower rates. Grab that year-end bonus; sell stock acquired by the exercise of a company stock option; bill clients for as much work as possible if you're self-employed.

Take Capital Gains Now
Capital gains and qualified dividends for those in the higher tax brackets would be affected if the tax cuts are allowed to expire for the richest Americans. The capital gains rate would revert to a maximum of 20% for higher income filers (from 15% currently), and qualified dividends would resume being taxed at the regular tax rate of the filer, or as high as 39.6%.

This indicates that now is a good time to take any capital gains or qualified dividends. Selling assets now as opposed to 2011 could have positive tax consequences for higher income filers.

Let Us Help You
As you can see, this is a complicated year for tax planning. Please don't hesitate to come in and meet with us about your situation. There's still a lot we can do to minimize your tax burden for 2010.

Please note, to comply with IRS regulations, we need to advise that any discussion of federal tax issues in this blog is not intended or written to be used, and cannot be used by you, (i) to avoid any penalties imposed under the Internal Revenue Code or (ii) to promote, market or recommend to another party any transaction or matter addressed herein. For more information please go to http://www.lw.com/docs/irs.pdf