Avoiding tax on real estate transactions

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With most of the country experiencing a depressed real estate market, you may find it difficult to sell a business building or apartment house. To make matters worse, a sale could result in significant tax consequences for real estate property that has appreciated in value since it was acquired.

Fortunately, there is a way you may be able to avoid dire tax problems. Assuming that a suitable replacement property can be identified, you can arrange an exchange of properties. If the properties are considered “like-kind,” you generally do not have to pay current tax on the exchange.

Basic premise: The rules for like-kind exchanges apply to investment or commercial property. (They cannot be used for residential homes.) This refers to the nature, character or class of the property—not its grade or quality. For example, a swap of an office building for an apartment building of the same value can qualify as a like-kind exchange. As a result, neither party has to report taxable income.

Although other types of property may qualify under the rules, the majority of these transactions involve real estate. However, in the real world, trading real estate properties is usually not so simple.

Suppose you want to acquire real estate, but the owner is not interested in any of the properties that you own. The tax law allows you to take the like-kind exchange concept one step further. The exchange can involve multiple parties if the two owners cannot agree on the properties to be swapped.

Example: Tinker wants to acquire property owned by Evers. However, Tinker does not own any property that Evers desires in return. After discussing a number of locations, the two of them strike a deal with Chance. Evers agrees to take Chance’s property, Chance acquires title to a property owned by Tinker and Tinker obtains the property he wanted all along.

The IRS has approved the use of a qualified intermediary to facilitate the deal, as long as the intermediary is not connected with one of the other parties. Also, be aware that time restrictions are involved in a multiple-party swap. In general, the property you receive must be identified within 45 days of the original transfer, and you must take title within 180 days (or your tax return due date plus any extensions, if that is sooner).

Assuming like-kind properties are involved, the entire transaction may be tax-free if the deal is completed within these time frames. One catch: If you receive any money or property as part of the deal, the additional amount—called “boot”—is subject to income tax. On the other hand, no loss is recognized by the taxpayer who provides the boot. The assumption of a greater mortgage is also treated as taxable boot for this purpose.

Finally, be forewarned that the IRS is often suspicious of these transactions. This is a complex area of the tax law, so professional assistance is a must.

New portability provision for couples in 2012

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The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 provides a special federal estate-tax break for married couples. Under the recently enacted legislation, the estate-tax exemption may effectively be transferred between spouses. A new IRS notice provides some guidance on making this election. The future remains uncertain. That is good news. But here is some bad news: Unless Congress acts again soon, the “portability” provision will expire after 2012.

Background: Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the estate-tax exemption for an individual was gradually increased from $1 million to $3.5 million for decedents dying in 2009. At the same time, the top estate-tax rate was decreased from 55% to 45%. EGTRRA also “decoupled” the estate- and gift-tax systems and retained a lifetime gift-tax exemption of $1 million.

Then EGTRRA repealed the federal estate tax, but only for decedents dying in 2010. The estate tax was scheduled to be reinstated in 2011, with only a $1 million estate-tax exemption and a top 55% estate-tax rate. Subsequently, the 2010 law created an estate-tax exemption of $5 million with a top estate-tax rate of 35%. The government recently announced that the inflation-adjusted exemption for 2012 is $5.12 million.

Among other changes, the new law reunifies the estate- and gift-tax systems and allows portability of estate-tax exemptions for married couples.

How it works: If a deceased spouse’s estate does not exhaust the entire exemption, the balance becomes available to the estate of the surviving spouse. Thus, heirs may more easily benefit from the maximum $10.24 million in exemptions ($5.12 million for the estate of each spouse in 2012), but only if both spouses die before 2013.

Example: John White owns assets valued at $3.5 million, and his wife Mary owns assets worth $6 million. They each have designated their children as their primary beneficiaries. John dies in 2012, so the $5.12 million estate-tax exemption shelters the entire amount. Then Mary dies later in 2012. Because John’s unused exemption of $1.62 million is transferred to Mary’s estate, the combined exemption shelters the entire $6 million in assets she owns.

The new IRS Notice explains how to use the portability provision. Briefly, the estate can transfer any unused portion of the exemption for a deceased spouse to the surviving spouse by filing the requisite form for federal estate-tax returns. No affirmative election is required.  The estate will be treated as having made the portability election as long as a return is filed in a timely fashion. Other issues will be addressed in future pronouncements from the IRS.

Note: The rules pertaining to annual gift-tax exclusion remain in effect without any change. Therefore, you can reduce the size of your taxable estate in 2012 and the foreseeable future by giving lifetime gifts up to the annual limit ($13,000 per recipient in 2012). You should coordinate lifetime gift-giving with other aspects of your estate plan. Rely on your estate-planning advisers for guidance.

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The alternative minimum tax (AMT) could be out to get you. This stealth tax, originally aimed at only the highest echelon of taxpayers, is expected to apply to 4 million taxpayers on 2011 returns, according to the Tax Policy Center. Even worse, the number is projected to explode to more than 31 million in 2012, absent any new legislation.

If you haven’t taken the AMT “personally” before, now is probably the time. Here’s a quick review.

General rules: The AMT is a parallel tax system to your regular tax liability. After you have figured out your regular taxable income, AMT liability is calculated through four basic steps:

1. First, you must add certain tax preference items to your taxable income and make other technical adjustments required by law.

2. Then you subtract the special exemption amount on your tax return based on your filing status.

3. Next, apply the AMT rate to the net amount. The applicable rate is 26% on the first $175,000 of AMT income and 28% for amounts above $175,000.

4. Finally, compare your AMT liability with your regular tax liability. If the AMT is higher, you are required to pay the excess in addition to your regular tax liability.

The list of preferences and technical adjustments is too long for the space allotted here. In brief, you are required to add back certain itemized deductions and personal exemptions. That’s one reason why large numbers of taxpayers have become unsuspecting victims of the AMT. For instance, taxpayers who report high state income tax deductions are particularly vulnerable. 

Ever since the monumental Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was passed in 2001, Congress has gradually increased the exemption amounts to account for inflation. But these AMT “patches” have been relatively small. The latest increase is effective only for the 2011 tax year. Unless subsequent legislation is enacted, the exemption amounts are scheduled to return to the levels they were before EGTRRA.

For 2011 returns, the exemption amount for joint filers is $74,450  (up from $72,450 for 2010). If you are a single filer, the exemption amount is $48,450 (up from $47,450). Finally, for married couples filing separately, it is $37,225 (up from $36,225).

However, the benefit of these exemption amounts is reduced for certain high-income taxpayers. Each exemption is reduced by 25 cents for each dollar of AMT income over $150,000 for joint filers; $112,500 for single filers and heads of household; and $75,000 for married couples filing separately. Despite the regular increases in exemption amounts, these figures have not been adjusted in recent years.

Reminder: This is an extremely complex area of the tax law. It is recommended that you seek assistance from a professional tax adviser.

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A 401(k) plan is a well-established retirement savings vehicle. But can an employee tap into the 401(k) plan account if he or she needs to do so before retirement? It depends.

A typical plan may permit employees to make hardship withdrawals. However, IRS regulations allow hardship withdrawals only if a participant has an immediate and heavy financial need and lacks other resources. In addition, such distributions may be subject to income tax and a 10% early withdrawal penalty.

Possible solution: A plan can address these shortcomings by including a loan feature. If it is warranted, an employee may borrow the greater of (a) $10,000 or (b) up to one-half of the first $100,000 in the account without paying any tax or penalty.

As with other retirement plan features, loan programs must meet regulatory requirements of the Department of Labor and the IRS. The eight key requirements are:

1. Availability: Loans must be available to all participants on a reasonably equivalent basis. To satisfy this requirement, loans must be available without regard to race, color, religion, sex or national origin. Also, when considering whether to make loans, plans can consider only such factors as commercial lenders would take into account, such as creditworthiness and financial need.

2. Nondiscrimination rules: A loan cannot be made available to highly compensated employees, officers or shareholders in amounts greater than those made available to other employees. This condition will not be violated merely because the loans do not exceed a maximum amount or a maximum percentage of a participant’s vested account balance.

3. Specific plan provisions: Loans must be made under specific provisions contained in the plan. The plan must state the procedure to apply for loans, the basis on which loans are approved or denied, the limitations on types and amounts of loans, the procedure to determine a reasonable rate of interest, the collateral that may secure loans, and an explanation of default and how the plan will deal with it.

4. Reasonable rate of interest: A loan must bear a reasonable rate of interest. This test is met if the rate charged is similar to what banks or other commercial lenders would charge under similar circumstances.

5. Adequate security: Loans must be adequately secured. In other words, you need more than just a promise to pay—there must be security that could be sold so that the plan would suffer no loss of interest or principal. The regulations allow plans to permit the participant to use up to one-half of his or her account balance to secure loans. In other words, if loans are limited to 50% of a participant’s account balance, the plan can avoid the need to acquire additional security.

6. Amortization: There must be level amortization.

7. Length of term: Loans must be repayable within five years, except where the loan is used to acquire the principal residence of the participant.

8. Frequency of payments: Payments must be made in quarterly installments or at more frequent intervals (e.g., monthly, weekly, etc.).

Remember, however, that 401(k) plans are intended for retirement saving. Typically, borrowing from the account should not be the first option to examine.

This is a technical area of the law. Whether you are an employer or an employee, obtain expert assistance.

IRS announces higher per diem rates

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The IRS pays extra-close attention to deductions claimed for business travel expenses. As a result, both employers and employees must meet strict recordkeeping requirements or face the consequences. Fortunately, you can obtain some relief by using IRS-approved per diem allowances in lieu of accounting for every expense.

The per diems are actually the allowances approved for travel by U.S. government employees. But a business owner cannot use either type of per diem allowance if he or she owns 10% or more of the company.

There are two basic per diem rates. The first is based separately on the employee’s travel destination. The second depends on the annual “high–low” rates established each year for certain areas.

Starting point: As long as employees properly account for their business travel expenses, including the cost of meals and lodging, employer-paid reimbursements are tax-free to the employees and deductible by the company. But this can lead to a recordkeeping nightmare. With a per diem allowance, employees do not have to keep receipts for all of their travel expenses. The employer simply pays the government-approved allowance—without any questions.

Employees do not even have to report the payments on their tax return. However, they still must substantiate the time, place and business purpose of their business travel.

In addition to adjusting the allowances for each specific travel destination, the government establishes a flat rate for certain high-cost areas. The list of high-cost areas includes business centers such as New York City and San Francisco. In addition, other areas may be included on a seasonal basis such as Vail in the winter or Nantucket in the summer. All the locations that are not listed as high-cost areas automatically fall into the low-cost category.

New rates: The IRS recently announced new per diem rates for the government’s 2012 fiscal year. (The fiscal year runs from October 1, 2011, through September 30, 2012, but these rates may be used throughout 2012.) Following a recent trend, the increases were relatively small. The IRS-approved per diem rate for the 2012 fiscal year ranges from $123 (the same rate that was used in 2011) to $367.

For employers using the high–low method, the per diem rate for high-cost areas is $242, up $9 from 2011. The rate for low-cost areas increased by $3 to $163. Note: The government initially intended to discontinue the high–low rates this year but subsequently relented due to public response.

To reduce the paperwork burden, you might use the high–low method for employees who travel extensively, especially if they generally travel to major cities. On the other hand, you can require other employees to use the specific-location method if they frequently travel to low-cost areas.

Finally, you can have those employees who travel infrequently keep detailed records of their actual expenses.

Remember that this is just an overview of the basic rules. Consult a professional tax adviser concerning your situation.

Strict recordkeeping rules for 2011 returns

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Year in and year out, charitable donations often provide big deductions for high-income individuals at tax return time. Deductions for charitable gifts may be claimed only by taxpayers who itemize their returns. But even itemizers are at risk if they do not have the requisite proof to back up their claims.

If you don’t measure up, you could be forced to forfeit all or part of your charitable deduction for 2011. Here is an overview of the most important rules.

Cash contributions: Under a recent tax law change, deductions for all monetary gifts, regardless of the amount, may be disallowed if the donor does not maintain either a bank record—including a canceled check, bank statement or credit card statement—or a written communication from the charity indicating the donor’s name, contribution amount and date of the contribution. Technically, this covers everything from million dollar grants made to a college or hospital to the spare change donated during the holiday season.

Contributions of $250 or more: The IRS also requires charitable donors to obtain a written acknowledgement from a charitable organization for gifts of $250 or more. The acknowledgement must be obtained by the time you file your tax return. It should include the amount of the check or cash donated, a detailed description of any property that was donated and the value of the benefit received if any goods or services were provided. Key exception: You do not have to establish a value for “intangible religious benefits.”

Contributions made through payroll deductions may be substantiated by pay stubs or a W-2 form. Note: Substantiation is not required if the donee organization files a return with the IRS providing the information to be included in an acknowledgement.

Quid pro quo contributions: If you make a “quid pro quo” contribution (i.e., a contribution made partially or fully in exchange for goods or services) for an amount more than $75, you must obtain a good faith estimate from the charity detailing the value of the benefit received. For example, say you attend a fund-raising dinner where the tickets cost $100 apiece and the dinner is valued at $40. The charity must provide a written statement limiting the deductible amount to $60 per ticket. However, a written statement from a charity is not required if you receive token goods, minimal services or intangible religious benefits in exchange for your donation.

There are a few other points to keep in mind. For example, if you gave charitable gifts of property exceeding $500 in 2011, additional information must be attached to your tax return. If your donation for noncash property exceeds $5,000, you are also required to provide an independent appraisal of the property’s value. Note: The cost of the appraisal is deductible as a miscellaneous itemized deduction (subject to the usual tax law limits for miscellaneous expenses).

In summary: These recordkeeping rules will keep you on your toes. However, as long as you have the proper documentation, you should be able to claim legitimate deductions for charitable donations on your 2011 return. Seek assistance from a tax professional.

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Frequently, business owners deal in “commodities,” such as the goods that the company might produce or sell to the general public. Yet they may pay scant attention to one of the precious commodities: time. Successful businesspeople understand this concept and treat time as one of their most valuable resources.

Knowing how to use time wisely increases your productivity and allows you to do “more with less.” As the business continues to grow, this lesson may enable you to provide greater profits through greater efficiency.

Be aware that different types of time can be used to solve different types of problems. For instance:

Uninterrupted time: If you have a complex problem to solve, it is best to take a large uninterrupted block of time to work on it. Sometimes you have to create that block by removing yourself from day-to-day interruptions. Leave the office. Forward your phone calls to voice mail. Then dig into the problem.

Reflective time: This is the time for evaluation. “Am I going in the right direction? Am I using my abilities and resources effectively? How can we improve what we are doing?” Without reflective time, you run the risk of running amok in the wrong direction.

Relaxation time: Most people need a change of pace, a time to relax and recharge their batteries. Failure to provide this time can lead to loss of energy and a high level of stress.

Downtime: We spend a large part of our time waiting for things to happen. Think of the time spent traveling to meetings, waiting for appointments, etc. Use this time to do routine tasks such as planning your calendar, revising a report, catching up on required reading, drafting a short memo, etc.

Keeping those differences in mind, here are four ways you might better manage your time:

*When it is feasible, delegate responsibility, not just tasks. Don’t feel that you have to do everything yourself.

*Follow up on results instead of “sweating the small stuff.” Keep your eyes on the big picture, and avoid being bogged down in the mundane.

*Collaborate with first-rate people. This reflects on your organization.

*Use technology to decrease time spent performing routine tasks. For example, communication is almost instant through the use of e-mail, smartphones, etc. Don’t spend a lot of time filing and storing documents when electronic archiving will suffice. Embrace faster and more efficient ways of doing business.

Last, but not least: Outsourcing is another possible method to save time. Your business advisers may be able to provide assistance or make recommendations that make sense for your operation.

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For many businesspeople, retirement is the “last frontier.” Will you have saved enough to live comfortably on a fixed income? Will you be forced to make drastic changes in your lifestyle? Will you be able to live long in relatively good health? Will you happily ride off into the sunset?

Although your overall fate is still unknown, you can improve the likelihood of a happy retirement by assessing your situation and reacting accordingly. Here are several suggestions to follow:

*Figure out how much income you will need in retirement. Start with the amount of income you need right now. Although estimates of your exact requirements will vary widely, you can assume that you will need an amount close to your current income, minus some obvious amounts such as the monthly mortgage payment if your home is or will be paid off and college expenses if the children have already graduated. Caveat: While you may not have to save extensively for retirement anymore, retirement saving cannot end completely.

*Figure out how much you will receive from outside sources. This includes amounts you can expect to receive from Social Security and qualified retirement plans and IRAs if you have been able to set aside funds in these vehicles. Of course, Social Security remains a political “hot potato,” and its future remains somewhat uncertain for Baby Boomers and subsequent generations. Nevertheless, you can obtain projections under current law by accessing the online calculator provided by the Social Security Administration (SSA). The SSA says the average retired single worker received $14,000 a year in 2011; $23,000 for a couple.

*Figure out how much income you will need from your investments. Once you have figured what you will need and what you will receive, you can determine the amount needed from investments to pick up the slack. But understand that this income will have to sustain you through a hopefully lengthy retirement. As life expectancies continue to increase due to medical advances, the projected needs of investors increase, too. If you are retiring this year, you may need to plan for an additional 25 or 30 years of living—maybe more.

*Figure out how to invest. There are a wide variety of investment options at your disposal. Of course, you must balance the potential rewards against your tolerance for risk. Everyone’s situation is different, so develop a plan of action with the assistance of your investment advisers.

If you find that you are significantly short of meeting your goals, at least there is some comfort in knowing that you are not alone. Among workers who are older than 45, only 54% have managed to save $25,000 or more, despite several periods of robust growth in the equities markets.

In a pinch, you may consider scaling back, moving to a less expensive location and delaying retirement for a year or two. Doing so gives you longer to save, provides a longer time for savings to grow, reduces the time you will be living on a fixed income and increases your Social Security benefits.

Finally, know that the trail to retirement does not have to be a lonely one. Rely on professional advisers to show you the way.

How to organize your key records

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The IRS generally requires taxpayers to shoulder most of the recordkeeping responsibilities. If you have not kept the necessary tax records in the past—or if your recordkeeping has been inadequate—make it your New Year’s resolution to improve in 2012.

Despite the hassle, you can make the process go a lot smoother if you organize your records in a logical fashion. Furthermore, using electronic recordkeeping methods may help simplify matters.

Most important, don’t wait until later in the year to get going. The longer you wait, the harder it will be. In the worst-case scenario, you will not have the records to support your claims when it is time to file your tax return. Here are several ways you may be able to relieve some of the stress.

*Keep a diary or ledger to record expenses that may be claimed as itemized deductions. The list includes interest expenses, charitable contributions, state and local income taxes, medical and dental expenses, miscellaneous expenses, casualty and theft losses, etc. You may want to maintain a separate diary for a detailed category of expenses.

*Set up a filing system for expenses and income. You might keep infrequent items together in a separate folder. However, travel and entertainment expenses should be handled separately due to the extensive substantiation requirements. In general, you must document the date, amount of the expense, the business purpose and other details (depending on the nature of the expenditure). You must keep receipts for items of $75 or more.

*Review your expenses on a regular basis. It is much easier to utilize tax planning during the year if you know where you stand. For instance, you might total up the expenses recorded in your diary at the end of each quarter. If you wait until the year is over, it may be too late to take action.

*Store your records in a safe place. Even the best record-keeping system will not do you any good if you cannot retrieve the records. Consider storing valuable documents in a fire-resistant strong box. You might keep check registers, credit card statements and the like in a safe deposit box. Back up any electronic records.

*Adjust your system over time as needed. No matter what kind of recordkeeping system you decide to adopt, try to remain flexible. A change in circumstances—for example, the purchase of a home—may require changes in your setup. Reminder: The system is for your benefit, not your burden.

Normally, the statute of limitations on IRS adjustments is three years. But the limit is doubled to six years for a return that omits 25% or more of an individual’s income. And there’s no time limit whatsoever if fraud is involved. To be on the safe side, it is often recommended that you hold onto your records for at least ten years.

Reminder: Help is just a phone call or e-mail away. Your professional tax adviser can provide assistance in this area. In addition, you can discuss tax-saving opportunities that may be available on your 2011 return.

Writing off a hodgepodge of expenses.

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As the year quickly draws to a close, you may be looking to increase your itemized deductions to offset highly taxed ordinary income. What about those random expenses that often seem to fall through the cracks? If you qualify, you may be able to deduct a portion of your miscellaneous itemized expenses.

Background: Miscellaneous expenses are generally not big-ticket items, but they can add up to a sizeable deduction at tax return time. The main hurdle is your annual deduction, limited to the excess above 2% of your adjusted gross income (AGI) for the year.

For simplicity, let’s say that your AGI for 2011 is an even $100,000 and you have incurred $1,950 of miscellaneous expenses during the year. In that case, your deduction is zero because you don’t clear the 2%-of-AGI mark.

Miscellaneous expenses are often referred to as a “hodgepodge” of deductible expenses. However, they are generally attributable to one of two categories: production-of-income expenses or employee business expenses.

Production-of-income expenses: This group includes expenses related to the production of income through investments, financial planning, retirement planning and tax assistance. Although this list is not all-inclusive, some common examples are safe deposit rentals to store nontax-exempt securities; accounting fees and legal fees to produce or preserve income; custodial fees for income-producing property and IRAs; fees paid to collect interest or dividends; hobby expenses (up to the amount of hobby income); fees for investment and tax counsel; appraisal fees for charitable contributions and casualty losses; and the cost of services, periodicals, manuals and other materials related to tax assistance. Note that the cost of having your tax return prepared by a professional is deductible as a miscellaneous expense.

Employee business expenses: The other main group of miscellaneous expenses consists of unreimbursed employee business expenses. It includes such expenses as dues paid to professional societies; union dues; employment-related education; malpractice insurance premiums; qualified home office expenses; subscriptions to professional journals and magazines; work clothes or uniforms; cellular phones and home computers (when required as a condition of employment); and qualified travel and entertainment expenses (but only 50% of entertainment costs are eligible for the deduction).

Furthermore, the cost of seeking employment—for example, payment for employment agency fees and résumé services—may be deductible as a miscellaneous expense, even if you don’t end up with the job.

As is usually the case with taxes, there are several exceptions to these general rules, so be sure to obtain expert tax advice. Reminder: The cost of tax assistance itself is deductible as a miscellaneous expense, subject to the 2%-of-AGI limit.

Tax break for retirees still available in 2011.

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A federal tax law passed late in 2010—the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act—extended a unique planning opportunity for certain retirees. Under this legislation, an individual age 70½ or older can transfer funds directly from an IRA to a qualified charitable organization without paying any tax on the distribution.

Significantly, the “charitable rollover” counts as a required minimum distribution (RMD) for the 2011 tax year. Under the rules for RMDs, an individual age 70½ or older is generally required to receive distributions each year.

Technically, the charitable rollover break expired after 2009. But the 2010 law reinstated the provision retroactive to January 1, 2010, and extended it through December 31, 2011. In other words, you have until the end of this year to take advantage of this tax provision.

Background: In the past, you could not directly transfer funds tax-free from an IRA to a charitable organization. Instead, you were required to pay tax on the distribution, regardless of your charitable intentions. The tax law also worked against retirees who wanted to use IRA funds for charitable donations but no longer itemized their deductions.

The Pension Protection Act of 2006 (PPA) changed the rules for individuals age 70½ and older. It allowed these retirees to transfer IRA funds directly to charity up to an annual limit of $100,000. Although no tax deduction was allowed, donors were not taxed on the distribution, either. The PPA tax break was subsequently extended through 2009. This provision was extended again through 2011 by the 2010 legislation.

A qualified distribution is one from an IRA that would otherwise be taxable. The distribution must be made directly from the IRA trustee to the charitable organization. In other words, you cannot handle the funds and then transfer them to the charity’s coffers.

Furthermore, the contribution must qualify as a charitable donation. If the deductible amount decreases because of a benefit received in return—a dinner at a fund-raising event, for example—or the deduction would not be allowed due to inadequate substantiation, the exclusion is not available for any part of the IRA distribution.

Under a special rule for charitable donations, the IRS treats distributions from an IRA funded at least partially with nondeductible contributions as coming first from taxable funds and then from nontaxable funds. Caveat: All of the taxpayer’s IRAs are grouped together for purposes of this calculation. Therefore, you cannot single out just one account.

Finally, an IRA participant is generally required to begin receiving RMDs in the year after the year in which he or she turns age 70½. A qualified charitable distribution counts toward this requirement.

Be aware that the rules also apply to Roth IRAs. Roth IRA distributions to individuals older than age 59½ are usually tax-free. But a portion of a distribution may be taxable for a Roth in existence less than five years. If you have both a traditional IRA and a Roth IRA, it generally makes sense to use the traditional IRA first for charitable distributions.

The charitable rollover break for retirees could be extended again by new legislation currently being discussed in Congress. We will keep you posted.

Key factors to consider in process.

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What is your small business currently worth? It is difficult to put a price tag on a business that is not publicly traded. Typically, the value of a family-owned business will exceed the total value of the hard assets, such as equipment and inventory. In addition, assigning a value to intangible assets such as goodwill is a difficult proposition, at best.

Frequently, it makes sense to have a business appraised by a qualified professional, especially if you intend to sell it in the near future.

More information: There are several ways a qualified appraiser can assess the key aspects of a business to arrive at a final figure. As part of the process, the appraiser will provide a valuation report, explaining in detail the specific methodology used for the valuation. This will be important when the buyer conducts its own due diligence. The chances of consummating a deal will increase if the buyer knows that he or she is dealing with a professional.

However, this is not the be-all and end-all. The appraisal should be viewed as just the starting point for negotiations. For instance, one buyer may have strong reasons for acquiring your company and could be willing to pay more than the amounts offered by other interested parties. Conversely, another buyer might be looking to merely enhance an existing operation and may not be willing to pay for the company’s going-concern value. It is important to analyze the reasons behind the purchase before you establish a price.

Some of the key aspects that should be considered in this process are

• Both the primary and secondary factors influencing buyers
• Different ways to add value before the sale occurs
• Necessary adjustments to financial statements (especially those that portray your company in a favorable light)
• The methods and formulas used to put a price tag on a business

Note: Other adjustments may be required if you are planning to sell only part of the business. Of course, your plans may change.

After the professional appraiser has established an approximate value for the business, you must use your negotiating skills to come to an agreement. Depending on the situation, you may be able to realize the full value of the business, or you might be willing to accept a slightly lower price if you are looking to sell quickly. Obtain guidance from your business broker concerning the going rate for a business such as yours.

One option is not to set a listing price at all. Instead, you might contact potential buyers and provide them with information about your business. Then you solicit bids from this select group and accept the highest bid. This process may help you realize a competitive price for your business in a relatively short period of time.

The best approach is to use the services of a professional adviser every step of the way. This can help ensure that you have established a reasonable and accurate value for your business in today’s marketplace. Alternatively, you may determine that it is not a good time to sell.

Tax ramifications when obtaining a divorce

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A divorce can be a difficult and emotional process. Besides facing a dramatic change in lifestyle, you must deal with the financial consequences of the dissolution of the marriage. This includes certain tax implications for each ex-spouse.

Basic premise: State law controls the distribution of assets in a divorce. For residents of the nine community property states—Arizona, California, Idaho, Louisiana, New Mexico, Nevada, Texas, Washington and Wisconsin—the assets you have accumulated during the marriage are divided 50/50. In other words, each spouse is entitled to half of the total community property, minus any liabilities. However, assets owned by either spouse prior to the marriage or assets received by gift or bequest during the course of the marriage are treated as belonging solely to the recipient spouse.

In all other states, assets are split under equitable distribution rules applicable to that particular state. That may work out to a 50/50 split, but not necessarily. Of course, the spouses can create their own legally binding agreement regarding the division of assets.

Generally, there are no federal income or gift-tax consequences to transfers triggered by a divorce. If this tax-free transfer rule applies, the spouse receiving a capital asset assumes its existing tax basis and holding period. Currently, appreciated assets held longer than a year may qualify for a maximum tax rate of 15% if sold before 2013 (0% for certain low-income taxpayers). A capital asset sold at a loss can offset capital gains realized during the year and up to $3,000 of ordinary income in 2011.

The tax-free transfer can take place before the divorce or at the time it becomes final. Tax-free treatment also applies to postdivorce transfers if made “incident to the divorce” (i.e., within one year after the end of the marriage or, if the transfers are made pursuant to a divorce or separation agreement, within six years after the end of the marriage).

However, be aware of a major exception to the tax-free transfer rule for employer-provided retirement accounts such as 401(k) plans. To qualify for a tax-free transfer, the divorce decree must include special language establishing a “qualified domestic relations order” (QDRO). If a QDRO is used, each ex-spouse is liable for tax on his or her share of the assets. Other special rules apply to distributions of IRAs. See your professional tax adviser for more details.

Finally, you should know that alimony paid as part of a divorce agreement is deductible by the payor and taxable to the recipient. Conversely, child support payments are neither deductible nor taxable. These tax aspects should be factored into the negotiations.

Reminder: This is only a brief summary of several key economic ramifications to consider in a divorce proceeding. Be sure to obtain expert advice every step of the way.

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Are your workers stuck in a rut? Are they depressed over the uncertain state of the economy? Are you looking for ways to motivate employees to perform at a higher level?

Of course, higher compensation and other tangible perks may entice workers to expend greater effort. But those measures can only go so far before the same or similar problems are likely to resurface. Alternatively, there are several low-cost ways to improve company morale that might reverse the trend. Here are seven commonly used methods to examine.

1. Find out what motivates your employees. Have them fill out a questionnaire about issues such as career development, leadership, praise and recognition, performance evaluation and other work-related aspects. Take the time to show your employees that you are interested in hearing what they have to say. This demonstrates a commitment to improving the workplace environment.

2. Establish a connection between the company’s mission and individual goals. Do not make it “all about the company.” For instance, you might set up a display showing significant moments in your employees’ lives. The employees can provide photos, descriptions and memorabilia. Paint a picture of how each employee’s actions fit into the larger goals and vision of the company.

3. Give your employees the resources they need. Set up manageable goals for workers and periodically review their progress. Encourage top performers to share their wisdom and experiences with others. Example: Each month, a different employee can provide insights into solving common problems. Recognize key accomplishments and success stories.

4. Create a team spirit within the organization. This can be as simple as establishing casual Fridays or modified summer hours. Or you could use t-shirts or other theme apparel to promote unity. Give company-wide work breaks as a reward for group achievements. Encourage employees to join pleasurable activities, such as softball or a theater outing, that they can share with others. Do not make work just about work.

5. Communicate, communicate, communicate. How can you reasonably expect employees to meet goals if they do not know what they are? Spell out your main objectives, preferably in writing. Employees are more likely to be successful if they understand management’s expectations. Workers on the same level may also be encouraged to point others in the right direction without any prompting from above.

6. Hold employees accountable. Break down long-term goals into short-term milestones, and show workers how to reach them. Keep an “open door” policy so workers can freely discuss the objectives at hand or other issues they may confront. Help employees identify challenges, and explain how they can work cohesively to overcome obstacles. Encourage your staff to be problem-solvers, not problem-causers.

7. Take your leadership role seriously. Exemplify the behavior you would like to see in your employees. Do not hide out in an upstairs office; be visible on the floor where work is being done. Be enthusiastic and confident about the company’s vision and its future. Finally, make improving company morale a top priority.

There are no absolute guarantees, but spirits may rise if you implement these steps. Best of all, there is little risk in trying them out.

Tax strategies for individuals and businesses

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The end of the year is often the preferred time for tax planning. Reason: You may have the flexibility to shift income and deductions to your tax benefit. However, tax planning in 2011 is shrouded in doubt as talk of major tax reform heats up. At this writing, there has been no definitive resolution of the federal budget dilemma by the government, which has commissioned a “super panel” to make recommendations. This could ultimately result in new tax legislation.

Nevertheless, several tax strategies for both individuals and businesses appear to be relatively “safe” in this uncertain environment. Here are some prime examples.

2011 Tax Strategies for Individuals

Capital gains and losses: If it is warranted, you may realize capital losses to offset capital gains from earlier in the year. Any excess can offset up to $3,000 of ordinary income in 2011. Conversely, capital gains realized at year-end may absorb prior capital losses. For 2011, net long-term capital gain for the year is taxed at a maximum rate of 15%, while the rate is 0% for taxpayers in the regular 10% or 15% brackets. (These tax breaks are scheduled to expire after 2012.)

Charitable gifts: Generally, you can deduct the full amount of cash donations made before the end of the year. If a donation is made by credit card, you can deduct the gift on your 2011 return, even if the charge is not actually paid until next year. Caveat: The tax law includes strict substantiation rules for monetary contributions and additional record-keeping requirements for gifts of property.

Alternative minimum tax: Despite another bump in the exemption amounts, you still may be among the millions who owe the alternative minimum tax (AMT). Have your professional tax adviser estimate your AMT liability for 2011. Depending on the outcome, it might make sense to shift certain “tax preference items” to 2012 to avoid or reduce AMT liability. Alternatively, you might accelerate income into this year if the AMT rate is lower than your expected top tax rate. The AMT rate is 26% on taxable income up to $175,000; 28% above that figure.

Family income-splitting: You may be able to reduce the overall family tax bill by shifting income-producing assets to family members, such as your children, in lower tax brackets. However, the “kiddie tax” may undermine this strategy. Generally, unearned income over $1,900 received in 2011 by a child younger than 19 or a full-time student younger than 24 is taxed at the parents’ top marginal tax rate.

Medical and dental expenses: You may deduct unreimbursed medical and dental expenses to the extent the annual total exceeds 7.5% of your AGI. When it is feasible, try to bunch nonemergency expenses (e.g., new eyeglasses or dental cleanings) in the tax year that provides the best opportunity for a deduction. For instance, if you have already cleared the 7.5%-of-AGI hurdle for 2011, any additional expenses are deductible.

Estimated tax penalties: An “estimated tax penalty” may be assessed if you do not pay sufficient income tax during the year through any combination of withholding or quarterly installments. But no penalty is imposed if payments equal to 90% of your 2011 liability or 100% of your 2010 liability (110% if AGI was above $150,000) are made. When possible, adjust withholding to qualify under one of these “safe harbor” exceptions.

2011 Tax Strategies for Businesses

Business assets: Under Section 179 of the tax code, a business may “expense,” or currently deduct, the cost of qualified business assets placed in service during the year. For 2011, the maximum expensing allowance is $500,000. In addition, a business may still qualify for 100% “bonus depreciation” deductions for certain new (but not used) assets placed in service before 2012. These two tax breaks may be combined for an unprecedented write-off in 2011.

Qualified small business stock: If you invest in “qualified small business stock” in 2011, you may be able to exclude tax on up to 100% of the gain on sale if the stock is held at least five years. (The exclusion was increased from 50% and 75% in previous versions.) This enhanced tax break expires on December 31, 2011. It may represent a viable opportunity to inject more cash into your own small business.

Bad business debt: In these uncertain economic times, a business may have difficulty collecting outstanding debts. As a general rule, the bad debts of a business may be deducted from gross income when they become worthless. Business owners should keep records of all collection efforts, such as letters, phone calls, e-mail communications and collection agency activities. This documentation can support deductions based on the worthlessness of the debts.

Repairs vs. improvements: If you simply repair a business asset, you may currently deduct the entire cost. In contrast, the cost of an improvement to business property must be capitalized. When possible, you might make minor repairs before the end of the year to offset your taxable income for 2011. Caveat: If you make repairs and improvements at the same time, the IRS may lump in the cost of the repairs with the improvements as part of a general betterment plan. In that case, the repairs are not currently deductible.

Section 199 deductions: A deduction under Section 199 may be available to a business entity with qualified domestic production activities. For 2011, the so-called “manufacturing deduction” is equal to the lesser of 9% of taxable income from qualified production activities or taxable income. Do not think that the Section 199 deduction is limited to traditional manufacturing firms. Obtain professional guidance concerning your operation.

Business supplies: A business can generally deduct the routine supplies it purchases during the year, even if some of the supplies are not used until the following year. When appropriate, your company might buy more supplies in December to increase its deduction for 2011.

Remember that this is only an overview of several common year-end tax-planning strategies. Also, as noted above, the tax laws are subject to change. Consult a professional tax adviser concerning your situation.

Five common mistakes to avoid

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If you have been working a long time, you may be looking forward to retirement in the not-so-distant future. Hopefully, you will be in good health at that time and able to pursue your favorite activities.

But the “golden years” may be tarnished if you are not careful. Here are five common mistakes that can hinder your ability to retire comfortably and securely.

1. You are overburdened with debt. Owing money is not necessarily fatal to a happy retirement. But credit card debt with high interest rates can be quite damaging if you cannot figure out a way to dig yourself out. It is especially difficult to set aside funds for retirement when you are facing large credit card bills each month. Make debt reduction a top priority.

2. You siphon off retirement savings for college expenses. If you are like many parents, you may try to pay off most, if not all, of the cost of your children’s college education. However, if you “rob Peter to pay Paul” by raiding your retirement accounts, you could be sacrificing your own retirement security. Generally, you will also have to pay a 10% penalty tax on top of the regular income tax on distributions from qualified retirement plans and IRAs made before age 59½. Distributions are taxed at ordinary income rates reaching as high as 35%.

Furthermore, you will be missing a chance to teach your kids about the value of savings. There are many ways to help finance the cost of college, but you cannot take out loans for retirement.

3. You have no “cushion.” Frequently, a household is almost entirely dependent on the compensation earned from a single employment source. If the main breadwinner loses his or her job, the family’s savings could be depleted, including any amounts that have been set aside for retirement. It makes sense to create an emergency fund that can tide you over until you are able to get back on your feet. You might consider a second job or a sideline business to protect against the worst-case scenario.

4. You do not have any long-term investment strategies. Retirement-savers may change their investment allocations in knee-jerk reactions to the financial news. Of course, there are no absolute guarantees, but it is generally advisable to develop plans for the long-term and to stick with them through some of the inevitable ups and downs.

Do not let emotion play a major role in investment decisions designed to produce income for retirement. But that is not to say you should maintain the status quo forever: Your plan should be adjusted periodically to take into account economic events, your time horizon, your tolerance for risk and your overall objectives.

5. You do not have any retirement plans. Probably the worst mistake you can make is to ignore the need to address a looming retirement. Naturally, you cannot foresee every contingency or blip on the screen, but having a plan in place will reduce the potential dangers you face.

With professional assistance, you should be able to approach the future with a greater sense of security. Gather all the information you will need to make intelligent decisions.

Find silver tax lining in dark cloud

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What a year it has been. In 2011 we have witnessed devastation caused by a wide variety of natural disasters, ranging from tornadoes to floods to wildfires. Although it is a small consolation if your home or other property is damaged as a result, at least you may be able to deduct a casualty loss on your tax return.

Basic rules: You may qualify for a casualty loss deduction if damage is caused by an event that is “sudden, unexpected or unusual.” This not only includes natural disasters already mentioned but also automobile collisions and frozen pipes bursting. The same basic rules apply to thefts of your property. However, you are not entitled to any tax relief for damage occurring over a long period of time, such as damage from a drought.

How much is deductible? It depends on whether the property damaged is personal or business property. For personal property, the deduction is limited to the excess above 10% of your annual AGI after subtracting $100 per casualty event. (This $100 “floor” was temporarily raised to $500 for 2009 only.) For example, if your AGI for 2011 is $100,000 and you suffer a loss to your home of $20,000, your deduction is limited to $9,900 ([$20,000 – $100] – [10% of $100,000]).

In contrast, there are no such limits for business property. The full amount of the eligible loss can be deducted on the company’s return.

The amount eligible for the deduction is the lesser of (1) the difference in the property’s value before and after the casualty or (2) the adjusted basis in the property.

But you must reduce the deductible amount by any insurance proceeds you receive.

Special tax break: If you own damaged property located in an area that is officially declared to be a “federal disaster area,” you could be entitled to a quick tax refund. In that case, you can elect to deduct your casualty loss on the tax return for the prior year. In other words, if you suffered a loss in a federally designated disaster area in 2011, you may file an amended return for 2010.

Be aware, however, that the IRS often challenges casualty loss deductions. The best proof you can offer is photographs or videotapes of your property as it currently exists. In other words, obtain documentation before a casualty occurs. The visual proof can be compelling when coupled with snapshots of the property immediately after a casualty occurs.

To further support your position, you should obtain an independent appraisal of the damage. The appraisal itself is deductible as a miscellaneous itemized deduction (subject to a 2%-of-AGI floor).

In summary: Your professional tax advisers can help you maximize the casualty loss deductions claimed on your return. Obtain assistance when appropriate.

New IRS ruling provides additional guidance

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Due to the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, business owners may be able to take advantage of renewed “bonus depreciation” deductions this year. In fact, this tax break is bigger than ever. The IRS recently issued new guidelines for bonus depreciation and expanded some provisions in the law.

Background: Previously, you could benefit from 50% bonus depreciation, coordinated with Section 179 deductions and regular depreciation deductions, for qualified new property placed in service before 2011. “Qualified property” includes property with a cost recovery period of 20 years or less, qualified leasehold improvement property, and certain software and water utility property.

The 2010 Tax Relief Act reinstated and improved the bonus depreciation tax break. It authorizes the following:

*100% bonus depreciation deduction for qualified property placed in service from September 9, 2010, through December 31, 2011 (through 2012 for certain other property).

*50% bonus depreciation for qualified property placed in service from January 1, 2012, through December 31, 2012.

The new IRS ruling addresses a number of issues related to 100% bonus depreciation. Here are four key points:

1. Step-down to 50% bonus depreciation: Under one previous law, you could “step down” from 50% bonus depreciation to 30% bonus depreciation if it suited your needs. For instance, postponing depreciation deductions may have been advantageous in your situation. But there is no step-down provision in the 2010 Tax Relief Act. The new ruling allows business owners to step down from 100% to 50% bonus depreciation in 2011.

2. Component depreciation: If you began to manufacture, construct or produce property before September 9, 2010, the components may qualify for 100% bonus depreciation. In other words, you can benefit for faster write-offs for qualified parts of the property. The new ruling explains how to elect the faster deductions for qualified components.

3. Restaurant and retail improvement property: Under prior law, qualified restaurant and retail improvement property was not eligible for 100% bonus depreciation. But the IRS says in the new ruling that these properties may fall within the definition of “qualified leasehold property.” Thus, property with a “dual character” may qualify for enhanced deductions.

4. Business vehicles: The “luxury car” rules limit annual deductions for business vehicles. Generally, the first-year depreciation deduction is increased by $8,000 as a result of 100% bonus depreciation. Therefore, business car owners may be able to claim a maximum deduction of $11,060 ($11,160 for a light truck or van) placed in service in 2011. The actual deduction is based on the percentage of business use. However, this effectively slows down the deductions that may be claimed in subsequent years.

The new ruling provides a special “escape hatch” based on a calculation involving 50% bonus depreciation. If this election is made, business owners may claim deductions over the usual cost recovery period for business vehicles.

Final point: The new ruling clarifies the rules relating to 100% bonus depreciation, but this remains a complex area of the law. Taxpayers must follow strict procedures regarding special elections. It is recommended that you obtain professional assistance from your tax advisers.

Tax may apply to cancellation-of-debt income

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Typical situation: An individual owes money to a third party relating to a loan for business or personal reasons. Due to extenuating circumstances, the lender agrees to a settlement of an amount less than the amount the borrower owes in principal and interest. So the full amount of debt is effectively wiped off the books.

Case closed ... right? Not exactly. The individual still faces potential federal income tax liability when a debt is completely or partially forgiven. In other words, you must pay tax on the reduction of the debt you benefit from. This is commonly referred to as cancellation of debt (COD) income in tax circles.

Background: If a debt is forgiven or canceled, the benefactor must report the amount as taxable income on his or her personal tax return. A business debt is reported on the appropriate return for the business entity or sole proprietorship. For this purpose, a debt includes any indebtedness for which the party is legally liable or indebtedness that attaches to property owned by that party.

Similarly, the debtor is required to report any interest attributable to the debt that is being forgiven or canceled. It’s a double whammy.

New case: A taxpayer who attended college in the 1980s borrowed money from the Connecticut Student Loan Foundation (CSLF) to help pay for school. At some point, the taxpayer became delinquent in the payments. Eventually, he settled the debt with CSLF by paying $45,000 of the $73,000 he owed, at a discount of $28,000. Result: The Tax Court says the taxpayer now owes tax on $28,000 of COD income.

Be aware, however, that there are several key exemptions to the rules for COD income, including student loans requiring the student to work after school for a specified time in a designated profession and certain student loans issued by tax-exempt organizations. Also, COD income does not have to be realized if the payment of debt would have been tax-deductible. (This exemption only applies if the cash method of accounting is used.)

Furthermore, the rules for tax on COD income generally do not apply to insolvent taxpayers or those in bankruptcy proceedings. Other special rules apply to indebtedness of farms.

Finally, there is a specific exclusion from COD income for debt of a principal residence. The exemption, which was established by a recent tax law in the wake of the mortgage foreclosure crisis, is capped at $2 million of qualified principal residence debt. Technically, this tax break is currently scheduled to expire for debts discharged after 2012.

Final words: Do not simply assume you are in the clear. Obtain professional assistance regarding the tax consequences of debt forgiveness or cancellation.

Benefits of intentionally defective trusts

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Depending on your situation, it may be advisable to set up a trust to fail certain tax law requirements. Actually, it is not as drastic as it sounds. An “intentionally defective trust” (known as an IDT, for short) can be a valuable estate-planning tool, especially in this current interest rate environment.

But IDTs are not for everyone or at every available opportunity. Here is a brief review of this sophisticated estate-planning technique.

How it works: Usually, you transfer assets such as cash or securities to the trust, which then pays annual income to the designated beneficiaries. By giving up all rights to the assets, you are not responsible for any federal income tax on the earnings. This can be particularly beneficial if you are in one of the top income tax brackets. (The current top bracket is 35%.) The income tax is generally paid by the trust under a graduated tax rate structure, beginning at a 15% rate.

But be aware that the income tax brackets for trusts are highly compressed. In other words, the dollar amounts for each bracket are relatively small compared with the tax brackets for individuals, so the higher tax rates are reached relatively quickly.

Bottom line: The trust could end up paying more tax than you would have been assessed in your usual individual tax bracket. In that case, you are defeating one of your own objectives.

This is where an IDT can provide some much-needed relief. Assuming the trust document is properly structured, the trust will be treated as a “grantor trust” if it permits you to retain certain rights or interests. This means that the income will be taxed to you as the grantor rather than the trust—even though you are not receiving any of the annual income.

In addition to the income tax savings, current interest rates make it conducive to establish an IDT. Reason: The resulting gift-tax liability for the remainder is based on the assumed IRS interest rate at the time the trust is created. When interest rates are on the low side—as they have been through the beginning of 2011—the gift-tax consequences are favorable to the grantor.

Note, however, that an IDT could lead to estate-tax complications. That is because your taxable estate includes assets you have transferred to trusts and individuals where you retain possession or enjoyment of the transferred property. Essentially, you must give up complete control over the assets. Nevertheless, negative estate-tax consequences can be avoided with proper planning.

Caution: This is not a do-it-yourself proposition. Consult an experienced estate-planning adviser to determine if an IDT makes sense for your situation.

Practical tips for setting aside funds

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The price tag on a college diploma continues to escalate at a rate higher than the inflation rate. According to the College Board, tuition and fees for in-state students at four-year public colleges for the 2010–2011 academic year increased an average of 7.9% from the prior year. For out-of-state students, tuition and fees rose an average of 6.0%. And the cost at four-year private nonprofit colleges jumped an average of 4.5%. Meanwhile, inflation has remained close to the 3% level.

Despite these grim figures, you can put a sizable dent in the projected cost of a child’s college education, if you are dedicated. Consider these five practical suggestions:

1. Start saving money on a regular basis. Make this a top priority, along with paying the mortgage and meeting other monthly obligations. Review your expenses, and try to determine the amount you can safely set aside each month.

Although your outlays may be relatively small, especially at the outset, the savings can grow substantially over time if you start early enough. Plus, it is a lot less painful than if you wait until the day your child receives his or her college acceptance letter.

2. Investigate Section 529 plans. One of the innovative ways that parents can save for college is a Section 529 plan. If certain requirements are met, the funds contributed to the plan can grow without current tax and may be withdrawn tax-free if they are used for qualified education expenses.

There are two basic types of Section 529 plans: prepaid tuition plans and college savings plans. Generally speaking, prepaid tuition plans enable you to lock in future tuition rates at in-state schools. College savings plans generally provide more flexibility for choosing a school, but without the same guarantees.

3. Be tax smart about other investments. For instance, certain investments may generate income that is either tax-free or tax-deferred. You can also arrange to have the income paid out at regular intervals during the time your child will be attending school. Frequently, it makes sense to make investments in the child’s name.

Caveat: Under the “kiddie tax,” annual unearned income received by a child younger than 19 (or a full-time student younger than 24) is generally taxable at the top tax rate of the child’s parents to the extent it exceeds a specific threshold ($1,900 for 2011). One possible way to avoid or reduce tax complications is to invest in appreciating assets, such as growth stock.

4. Look into financial aid. While financial aid is often limited to the neediest families, your child still may be eligible for some type of state or federal financial assistance. This can come in the form of a grant, work/study program or a low-interest loan. Once your child has been accepted at a particular school, inquire about potential financial aid—it cannot hurt to ask.

5. Put your child on the payroll. If you own your own business, you can have your child work for you. Not only does your child save money for college but the wages you pay your child may be deducted by the business. However, the amount paid to your child must be “reasonable” for the services actually performed.

These are just five ideas to consider. There are other possibilities. Coordinate all college savings aspects into a comprehensive plan of action.

MEMORANDUM TO CLIENTS

Re:  Payroll Taxes and Minimum Wage Requirements for 2011

Date:  December 31, 2010

FICA-SOCIAL SECURITY

 The FICA payroll tax is comprised of a Social Security portion and a Medicare hospital insurance portion.

Wages subject to the Social Security portion will remain the same as the present, a maximum of $106,800 for 2011.  All wages are subject to the Medicare portion.

For the first $106,800 of wages, the FICA tax rate will remain at the present 7.65% for employers and will be 5.65% for employees.  All wages in excess of $106,800 – for both employers and employees – are subject to the 1.45% Medicare tax.

Self-employed individuals will pay a combined 13.3% FICA tax on the first $106,800 in self-employment earnings.  Self-employment earnings in excess of $106,800 are subject to a 2.9% Medicare tax.

FUTA UNEMPLOYMENT INSURANCE

 The 2011 taxable wage base for federal unemployment insurance remains at $7,000. The normal FUTA rate is 6.2%, but employers are given a 5.4% credit for the state unemployment tax they pay, making the federal unemployment tax 0.8%.  Deposits are required for any quarter that the employer’s cumulative liability reaches $500.

STATE UNEMPLOYMENT INSURANCE

The 2011 wage base for Kentucky unemployment insurance is $8,000.  The 2011 wage base for West Virginia unemployment insurance is $12,000. The 2011 wage base for Ohio unemployment insurance is $9,000.

 MINIMUM WAGE

The federal hourly minimum wage rate is $7.25. 

The state minimum wage is higher in some states than the federal rate.  For West Virginia, the minimum wage for employers of six or more employees at one location is $7.25.  The Ohio minimum hourly rate is $7.40 for employers who gross over $271,000, and $7.25 for those under.  For Kentucky employers, the minimum wage is currently the same as the federal rate, $7.25. 

ERISA- IRC SECTION 401(K) PLANS

 The 2011 maximum 401(K) contribution limitation is $16,500.  Under a catch-up provision, workers aged 50 and over as of the end of the tax year are allowed to contribute an additional $5,500 without violating discrimination rules and percentage of salary limitations in the current plan.

 EMPLOYMENT ELIGIBILITY VERIFICATION

 The U.S. Citizenship and Immigration Service (USCIS) has announced that employers must use the August 7, 2009 version of Form I-9, Employment Eligibility Verification Form.  Employers are required to use Form I-9 to verify the employment eligibility of newly hired employees, and for employment reverification when an employee's work authorization expires or an employee is rehired. Employers that do not use the revised form may be subject to penalties. The new form is available on the http://uscis.gov/.

Form I-9 “Employment Eligibility Verification” must be completed for all newly hired employees.  Retain Form I-9 for 3 years after the date of hire or 1 year after employment termination, whichever is later.  We recommend however, that the form be kept indefinitely with the employee’s other employment records.

The law provides for both civil and criminal penalties for those employers who fail to keep the necessary records or participate in prohibited hiring practices.

NEW HIRE REPORTING

You are required to report any new employee to a designated state new hire registry.  This information is to be reported to the state where the employer is located, and will be forwarded to a national registry by each state.  This information is used for matching against child support records for the purpose of locating parents, establishing an order, or enforcing existing orders.  It is also used to find and prevent fraudulent workers’ compensation and unemployment claims.  Call the Office of Child Support Enforcement at 202-401-9373 or access the website at http://www.acf.hhs.gov/programs/cse/ for more information. 

2011 FEDERAL TAX DEPOSIT RULES

 SUMMARY OF DEPOSIT RULES

*The lookback period is the twelve-month period ending with the prior June 30^th. See explanation below.

DEPOSIT SCHEDULE

There are two deposit schedules, monthly or semi-weekly, for determining when you deposit Social Security, Medicare, and withheld income taxes.  These schedules tell you when a deposit is due after a liability arises from a payday.  Prior to the beginning of each calendar year, you must determine which of the two deposit schedules you are required to use.

Your deposit schedule for a calendar year is determined from the total taxes (not reduced by any advance earned income credit payments) reported on your Forms 941 (line 11) in a four-quarter lookback period.  The lookback period begins July 1 and ends June 30 for application to each succeeding calendar year (for example, July 1, 2009 to June 30, 2010 is the lookback period for calendar year 2011).  If you reported $50,000 or less of taxes for the lookback period, you are a monthly schedule depositor; if you reported more than $50,000, you are a semi-weekly depositor.

The regulations provide a safe harbor for any deposit shortfall that does not exceed the greater of $100 or 2% of the required deposit, provided the shortfall is made up on a timely basis.

ELECTRONIC DEPOSIT REQUIREMENT

Beginning January 1, 2011, the IRS requires all taxpayers to make deposits using the Electronic Fund Transfer Payment System (EFTPS).  Taxpayers are required to deposit all employment taxes, excise taxes, and corporate income taxes using EFTPS.  Form 8109, Federal Tax Deposit Coupon, cannot be used after December 31, 2010. 

For deposits made by EFTPS to be on time, you must initiate the transaction at least on the business day before date the deposit is due.  If you are required to use EFTPS and fail to do so, you may be subject to a 10% penalty.

The IRS has released much-anticipated temporary and proposed regulations on the capitalization of costs incurred for tangible property. They impact how virtually any business writes off costs that repair, maintain, improve or replace any tangible property used in the business, from office furniture to roof repairs to photocopy maintenance and everything in between. They apply immediately, to tax years beginning on or after January 1, 2012.

These so-called “repair regulations” are broad and comprehensive. They apply not only to repairs, but to the capitalization of amounts paid to acquire, produce or improve tangible property. They are intended to clarify and expand existing regulations, set out some bright-line tests, and provide some safe harbors for deducting payments.

The regulations are an ambitious effort to address capitalization of specific expenses associated with tangible property. The regulations affect manufacturers, wholesalers, distributors, and retailers—everyone who uses tangible property, whether the property is owned or leased. The rules provide a more defined framework for determining capital expenditures.

Most taxpayers will have to make changes to their method of accounting to comply with the temporary regulations and will need to file Form 3115. Taxpayers who filed for a change of accounting method following the issuance of the 2008 proposed regulations will probably have to change their accounting method again.

The IRS has promised to issue two revenue procedures that will provide transition rules for taxpayers changing their method of accounting, including the granting of automatic consent to make the change. The regulations require taxpayers to make a Code Sec. 481(a) adjustment; this means that taxpayers will have to apply the regulations to costs incurred both prior to and after the effective date of the regulations.

The new regulations provide rules for materials and supplies that can be deducted, rather than capitalized. The rules provide several methods of accounting for rotable and temporary spare parts, and allow taxpayers to apply a de minimis rule so that they can deduct materials and supplies when they are purchased, not when they are consumed.

Costs to acquire, produce or improve tangible property must be capitalized. The regulations address moving and reinstallation costs, work performed prior to placing property into service, and transaction costs. Generally, costs of simply removing property can be deducted, but costs of moving and then reinstalling property may have to be capitalized.

To determine whether a cost incurred for property is an improvement, it is necessary to determine the unit of property. Generally, the larger the unit of property, the easier it is to deduct expenses, rather than have to capitalize them. The regulations provide detailed rules for determining the unit of property for buildings and for non-building tangible property. For buildings, the IRS identified eight component systems as separate units of property, requiring more costs to be capitalized. However, the new rules also provide for deducting the costs of property taken out of service, by treating the retirement as a disposition.

The new regulations require virtually every business to review how repairs, maintenance, improvements and replacements are handled for tax purposes, with both mandatory and optional adjustments made to past treatment as appropriate.

Please feel free to call this office for a more targeted explanation of how these new regulations impact your business operations.

The fate of the employee-side payroll tax cut along with a host of tax extenders and other expired provisions could be decided in coming weeks. A conference committee of House and Senate members is negotiating a full-year extension of the payroll tax cut and could add some or all of the tax extenders to a final package. Lawmakers also could extend the payroll tax cut without acting on any tax incentives.

Payroll tax cut

The Temporary Payroll Tax Cut Continuation Act of 2011 extended the employee-side OASDI tax cut through the end of February 2012. The employee-share of OASDI taxes is 4.2 percent for the two-month period, rather than 6.2 percent. The employer-share of OASDI taxes remains at 6.2 percent for the two month period. Self-employed individuals also benefit from a two percentage point reduction in OASDI taxes.

Unless extended, the employee-share of OASDI taxes is scheduled to revert to 6.2 percent after February 29, 2012. The White House and the leaders of the two parties in Congress agree that the payroll tax cut should be extended a full-year. They disagree, however, how to pay for the extension; even if it should be paid for at all.

Congress could extend the two-month payroll tax cut through the end of 2012 without paying for it. The 2011 payroll tax cut was unfunded. Congress appropriated to the Social Security trust funds amounts equal to the reduction in payroll tax revenues. The 2011 payroll tax cut was estimated by the Congressional Budget Office cost approximately $111 billion. Extending it through the end of 2012 is estimated to cost just as much if not more.

House Republicans reportedly have proposed a number of revenue raisers to offset the cost of extending the payroll tax cut through the end of 2012. One GOP proposal would extend the current pay freeze for employees of the federal government. Another GOP proposal would require higher-income individuals to pay increased Medicare premiums.

One possible revenue raiser, increasingly under discussion by Democrats, is a change in the taxation of so-called carried interest. Current law generally taxes carried interest as capital gains and not as ordinary income. Past efforts to change the tax treatment of carried interest have failed to pass Congress.

Extenders

The so-called tax extenders, popular but temporary tax provisions, expired at the end of 2011. Many taxpayers are surprised to learn that their particular tax break, whether it be the state or local sales tax deduction, the teachers’ classroom expense deduction, or the research tax credit, are temporary. The extenders have been routinely revived many times in the past. This year, however, could be different. Faced with record federal budget deficits, lawmakers may decide to extend only some of the expired provisions.

President Obama’s FY 2013 proposals

President Obama is expected to release his fiscal year (FY) 2013 federal budget proposals in early February, which will reignite debate over the Bush-era tax cuts. President Obama is expected to urge Congress to allow the Bush-era tax cuts to expire after 2012 for higher-income taxpayers, which President Obama defines as individuals earning more than $200,000 or families earning more than $250,000. In recent weeks, there has been speculation that President Obama may revisit those definitions in his FY 2013 budget, possibly raising the amounts.

Few Capitol Hill observers expect Congress to take any action on the Bush-era tax cuts before the November elections. Instead, Congress may take up some of President Obama’s other proposals. As in past budgets, President Obama will likely propose to extend some energy tax breaks for individuals and businesses, extend tax incentives for education and provide some targeted-tax breaks to businesses. President Obama has also promised to introduce proposals to encourage U.S. companies to “insource” jobs at home.

On some issues, such as energy and education, lawmakers may find common ground but negotiations are likely to go down to the wire. Our office will keep you posted of developments.

If you have any questions about the payroll tax cut, tax extenders or the various tax proposals under discussion, please contact our office.

The IRS reopened its offshore voluntary disclosure program in early 2012 in response to what the government described as strong interest among taxpayers. The reopened program, the third of its type in recent years, encourages taxpayers with unreported foreign accounts to make full disclosures in exchange for a reduced penalty framework. Like its predecessors, the terms and conditions of the reopened program are very complex. The IRS has promised to provide more details. In the meantime, the prior offshore disclosure programs are guides to how the IRS intends to implement the third, reopened program.

Previous disclosure programs

The IRS launched two previous offshore disclosure initiatives: one in 2009 and another in 2011. Both programs offered reduced penalties in exchange for full disclosure. In early 2012, the IRS reported it received 33,000 voluntary disclosures from the 2009 and 2011 offshore initiatives. The government has collected over $4.4 billion from the 2009 and 2011 programs. The IRS predicted it will collect more revenue as it continues to work cases.

Reopened program

The reopened program operates very similarly to the 2009 and 2011 programs but with some key differences. The previous programs were temporary. The 2011 program ended in mid-September 2011. The reopened program has no set end date. The IRS cautioned, however, that it could close the program at some future date. The decision to end the program is solely at the discretion of the IRS.

The reopened program requires taxpayers to file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as pay accuracy-related and/or delinquency penalties. Additionally, taxpayers must pay a penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. In comparison, the highest penalty in the 2011 program was 25 percent. IRS officials have said that the penalty was increased because the agency does not want to reward taxpayers who did not participate in the 2009 or 2011 disclosure programs because they anticipated that a future penalty would be lower.

In limited circumstances, taxpayers may qualify for a 12.5 percent penalty or a five percent penalty. Generally, taxpayers whose offshore accounts or assets did not surpass $75,000 in any calendar year may qualify for the 12.5 percent penalty.

The requirements for the five percent penalty are very narrow. The IRS has explained that taxpayers must meet four conditions: (1) The taxpayer did not open or cause the account to be opened; (2) the taxpayer exercised minimal, infrequent contact with the account, for example, to request the account balance, or update account holder information such as a change in address, contact person, or email address; (3) except for a withdrawal closing the account and transferring the funds to an account in the United States, the taxpayer did not withdraw more than $1,000 from the account in any year for which the taxpayer was non-compliant; and (4) the taxpayer can show that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation).

The penalty amounts in the reopened program are not set in stone, the IRS cautioned. It may eventually increase penalties in the program for all or some taxpayers or defined classes of taxpayers.

Quiet disclosures

One goal of the three programs is to caution taxpayers against so-called “quiet disclosures.” A quiet disclosure occurs when a taxpayer files an amended return and pays any tax delinquency without making a formal voluntary disclosure. The IRS warned taxpayers making quiet disclosures that they risked being sanctioned to the fullest extent allowed by law.

Critics

The offshore disclosure programs were not without their critics. The National Taxpayer Advocate recently told Congress that the IRS should streamline what is a very complicated process. The National Taxpayer Advocate also reported that IRS examiners were assuming that all violations were willful unless a taxpayer presented evidence to the contrary. It is possible that the IRS may revisit some of the terms and conditions of the reopened program in light of the National Taxpayer Advocate’s report.

If you have any questions about the reopened offshore voluntary disclosure program, please contact our office.

Taxpayers with children should be aware of the numerous tax breaks for which they may qualify. Among them are: the dependency exemption, child tax credit, child care credit, and adoption credit. As they get older, education tax credits for higher education may be available; as is a new tax code requirement for employer-sponsored health care to cover young adults up to age 26. Employers of parents with young children may also qualify for the child care assistance credit.

Dependency Exemption

In addition to the personal exemption an individual taxpayer may take for him or herself to reduce taxable income (Line 42 on Form 1040), that taxpayer may also take an exemption for each qualifying dependent who has lived with the taxpayer for more than half of the tax year. A dependent may be a natural child, step-child, step-sibling, half-sibling, adopted child, eligible foster child, or grandchild, and generally must be under age 19, a full-time student under age 24, or have special needs. The amount of the exemption is the same as the taxpayer’s personal exemption, $3,700 for the 2011 tax year and $3,800 for the 2012 tax year.

Child Tax Credit

Parents of children who are under age 17 at the end of the tax year may qualify for a refundable $1,000 tax credit. The credit is a dollar-for-dollar reduction of tax liability, and may be listed on Line 51 of Form 1040. For every $1,000 of adjusted gross income above the threshold limit ($110,000 for married joint filers; $75,000 for single filers), the amount of the credit decreases by $50.

Child and Dependent Care Credit

If a taxpayer must pay for childcare for a child under age 13 in order to pursue or maintain gainful employment, he or she may claim up to $3,000 of his or her eligible expenses for dependent care. If one parent stays home full-time, however, no child care costs are eligible for the credit.

Adoption Credit

Taxpayers who have incurred qualified adoption expenses in 2011 may claim either a $13,360 credit against tax owed or a $13,360 income exclusion if the taxpayer has received payments or reimbursements from his or her employer for adoption expenses. For 2012, the amount of the credit will decrease to $12,650, and in 2013 to $5,000.

Higher Education Credits

There are two education-related credits available for 2012: the American Opportunity credit and the lifetime learning credit. The American Opportunity credit amount is the sum of 100 percent of the first $2,000 of qualified tuition and related expenses plus 25 percent of the next $2,000 of qualified tuition and related expenses, for a total maximum credit of $2,500 per eligible student per year. The credit is available for the first four years of a student's post-secondary education. The credit amount phases out ratably for taxpayers with modified AGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers). The lifetime learning credit is equal to 20 percent of the amount of qualified tuition expenses paid on the first $10,000 of tuition per family. The phaseout for 2012 ranges from $52,000 to $62,000 ($104,000 to $124,000 for joint filers). Parents also find tax relief in saving for college though Coverdell accounts, section 529 plans and specified U.S.. savings bonds.

Extended Health Care Coverage

Effective since September 23, 2010, the new health care law requires plans to provide coverage for children until they attain age 26. Further, effective on or after March 30, 2010, children under the age of 27 are considered dependents of a taxpayer for purposes of the general exclusion from income for reimbursements for medical care expenses of an employee, spouse, and dependents under an employer-provided accident or health plan. Therefore, a plan must provide coverage to a child who is still a dependent up to age 26; but can do so up to age 27 without income tax consequences. A child includes a son, daughter, stepson, or stepdaughter of the taxpayer; a foster child placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction; and a legally adopted child of the taxpayer or a child who has been lawfully placed with the taxpayer for legal adoption.

Child Care Assistance Credit (for businesses)

Employers may take up to $150,000 of the eligible costs of providing employees with child care assistance as tax credit. These costs may include a portion of the costs of acquiring, constructing, improving, and operating a child care facility.

If you have any questions about these provisions and how they may benefit you, please contact our office.

The Treasury Department is authorized to offset a taxpayer’s tax refund to satisfy certain debts. A spouse who believes that his or her portion of the refund should not be used to offset the debt that the other spouse owes may request a refund from the IRS.

Offset

If an individual owes money to the federal government because of a delinquent debt, the Treasury Department’s Financial Management Service (FMS) can offset that individual's tax refund (and certain other federal payments) to satisfy the debt. The debtor will be notified in advance of the offset.

A taxpayer’s refund may be reduced by FMS and offset to pay:

• Past-due child support
• Federal agency non-tax debts
• State income tax obligations, or
• Certain unemployment compensation debts owed a state.

FMS advises taxpayers by written notice of an offset. FMS has explained that the notice will reflect the original refund amount, the taxpayer’s offset amount, the agency receiving the payment, and the address and telephone number of the agency. FMS will notify the IRS of the amount taken from your refund.

Form 8379

If a taxpayer filed a joint return and is not responsible for the debt of his or her spouse, the taxpayer may request his or her portion of the refund by filing Form 8379, Injured Spouse Allocation, with the IRS. Form 8379 may be filed with the original return or by itself after the taxpayer is aware of the offset.

The IRS has instructed taxpayers filing Form 8379 by itself to attach a copy of all Forms W-2 and W-2G for both spouses, and any Forms 1099 showing federal income tax withholding to Form 8379. Failure to attach these items may result in a delay in processing by the IRS.

The IRS has reported on its website that it generally processes Forms 8379 that are filed after a joint return has been filed in approximately eight weeks. The timeframe for processing a Form 8379 that is attached to a joint return is approximately 11 weeks (14 weeks if the joint return is filed on paper).

As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of February 2012.

February 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 25–27.

February 3

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 28–31.

February 8

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 1–3.

February 10

Employees who work for tips. Employees who received $20 or more in tips during November must report them to their employer using Form 4070.

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 4–7.

February 15

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 8–10.

Monthly depositors. Monthly depositors must deposit employment taxes for payments in January.

February 17

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 11–14.

February 23

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 15–17.

February 24

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 18–21.

February 29

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 22–24.

March 2

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 25–28.

March 7

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 29–March 2.