Similarly, some argue that because we have a "voluntary" system, taxes are optional. But voluntary only "means the government is trusting you to self-report how much tax you owe," instead of the government telling you what you owe, says George Willis, an associate clinical professor at Chapman University School of Law.

Bartering is tax-free: Bartering has blossomed in the recession, particularly online. But while no money changes hands, the value of the swaps is taxable income for both sides, Quijano says.

Internet revenue isn't taxable: Online entrepreneurs who believe this are in for a rude shock next year, says Barbara Weltman, author of J.K. Lasser's 1001 Deductions & Tax Breaks. That's when credit card companies and groups like PayPal must start reporting merchant sales to the IRS, she says.

Ill-gotten gains aren't taxable: Even if your line of work is theft, embezzlement, prostitution, drug dealing or some other illegal enterprise, that income is still taxable.

Cash isn't taxed: Tips, gambling winnings, extra bucks you earn under the table and money you find on street must be reported to the IRS and is subject to tax.  "The law requires reporting all your income, even if it's not on a Form 1099 or W-2," says Zack Goff, a senior tax analyst with The Tax Institute at H&R Block. The IRS has the tools to uncover unreported cash. "They can get access to bank account information and other third-party sources to, in a roundabout way, verify income," Goff says.

My dog is my dependent: "People think they can claim anyone living with them as dependents," Willis says. "The joke was, before the IRS required Social Security numbers (for dependents), people claimed their dogs and cats." There are exceptions, but dependents usually are children or other relatives who get more than half their financial support from you and live with you for more than half the year.

Home-office deduction triggers audit: This used to be true when anyone with a desk in the basement corner claimed it as a home office. Teachers were big offenders, saying they graded papers at home even though their principal place of business was the school, Weltman says. The rules were clarified in the 1990s, so people are less likely to mistakenly claim the deduction, and it's not the red flag to the IRS that it once was, she says.  Still, filers shy away from the deduction for fear of an audit, she says. "If you're entitled to take it, you should take it."

Extensions lead to audits: Filers suspect that if they request more time to file a return, the IRS will get suspicious and might pull them in for an audit. But extensions are routine and don't raise an eyebrow. What prompts an audit "is a guarded secret," says Dennis Raible, an accounting professor at Saint Joseph's University and a former IRS agent. Although, flags are raised when income listed on a return doesn't match what the employer reported or your claims seem way out of line compared to others in your locale, he says.

If you get a refund, you won't be audited: A refund doesn't mean you're in the clear, Quijano says. The IRS generally can audit returns filed within the past three years, but there's no limit to its reach if fraud is involved.

Kids and retirees don't have to file returns: It's not your age that determines whether you have to file but your income. For instance, singles under age 65 with $9,350 in gross income last year must file a return, as well as those 65 and older with income of $10,750 or more. The self employed with income of $400 or more also must file.

The rich don't pay taxes: "People don't understand how progressive the income tax is," says Len Burman, a public policy professor at Syracuse University. "Middle-income people think they are paying more than they are."  Sure, the rich can afford to hire accountants and lawyers to help shelter income from taxes, he says. But figures from the Tax Policy Center show the top fifth of earners pay 67 percent of the federal income taxes. The bottom fifth of earners actually get more back from income taxes than they paid in because of refundable credits and other tax breaks.

Most will pay the federal estate tax: This tax disappeared this year, but will be back in 2011. Still, last year 99.8 percent of deaths didn't set off the estate tax, according to the Tax Policy Center. Estate tax opponents often don't realize the millions — $3.5 million per person last year — that can be sheltered from this tax, Burman says. Others are against the tax because they dream of being rich someday. "But you have to be really rich to be subject to the estate tax," he says.

Obama Proposes Expanding SBA Loan Limits
From WebCPA

President Barack Obama has called for expanding the size of loans made through the Small Business Administration’s SBA Express program from $350,000 to $1 million. Obama also proposed on Friday to expand the Certified Development Company/504 program to provide more refinancing of existing commercial real estate mortgages. In his weekly address on Saturday, Obama urged Congress to move forward with these and other recent proposals to aid small businesses. “Let’s put more Americans back to work, and let’s give our small business owners the support to do what they’ve always done: the freedom to pursue their dreams and build our country’s future,” he said.

Last-minute strategies for year-end tax savings

2009 is quickly coming to a close but there is still time to possibly maximize your federal tax savings for the year. Many year-end tax planning techniques can help you save money. Because of the recession, some of the year-end strategies take on added urgency for individuals affected by a job loss or a reduction in income.

Bunching itemized deductions.If quitting smoking is one of your New Year’s resolutions, you might want to stop in December and possibly deduct the cost of participating in a smoking cessation program. Many medical expenses are deductible. However, medical expenses may only be deducted if they exceed 7.5 percent of your adjusted gross income. Our office can review your 2009 medical expenses and if you are close to the threshold for 2009, you may want to accelerate some elective medical expenses into 2009 to jump over the 7.5 percent floor.

Other expenses may only be deducted if they exceed two percent of your adjusted gross income and you itemize your deductions. These are known as miscellaneous itemized deductions and may also be bunched. They include certain unreimbursed employee expenses, tax preparation fees, certain job search expenses, and more.

Individuals who lost a job in 2009 and whose incomes have fallen need to carefully time their deductions. In some cases, it may be more valuable to defer bunching itemized deductions into 2010 rather than accelerating them into 2009. Our office can help you time your deductions for the maximum benefit.

Above-the-line deductions. Above-the-line deductions help minimize your tax bill because they reduce your adjusted gross income. Generally, above-the-line deductions are only available to taxpayers who itemize their deductions.There are also important income limitations.

One of the most valuable deductions for many individuals is the deduction for state and local real property taxes. You may be able to pre-pay state and local taxes for 2010 before the end of 2009 and take a deduction for 2009. Additionally, for 2009, individuals who do not itemize their deductions get a partial state and local property tax deduction. A non-itemizer single individual can deduct up to $500 in state and local property taxes paid in 2009. Married couples filing joint returns who do not itemize their deductions can deduct up to $1,000.

Another valuable deduction will expire at the end of 2009: the deduction for state and local sales tax when you purchase a new vehicle. The special deduction is available whether you take the standard deduction or itemize deductions on your return. Taxpayers who do not itemize will add this additional amount to the standard deduction on their 2009 return. At year-end, new car and truck prices are generally high across the county, especially after dealers emptied their inventories under the cash-for-clunkers program. If you qualify, the state and local sales tax deduction could help bring down the cost of a new vehicle. Generally, the new vehicle must be valued at $49,500 or less. There are important income limitations so contact our office before you make your purchase.

Charitable contributions.  Year-end charitable giving generally has always been a smart way to reduce current year taxes but tough substantiation requirements cannot be overlooked. Traditionally, charitable contributions (and other itemized deductions) phased out for higher-income individuals. However, that limitation is reduced by two-thirds for 2009 and does not apply at all in 2010, which makes charitable contributions more valuable not only to charities but also donors. Depending on your income, you may want to delay a charitable deduction into 2010 to take full advantage of the phase out of the limitation.

Retirement savings. The economic slowdown has caused many individuals to tap their retirement savings to help pay for everyday expenses. To discourage the use of pension funds and IRAs for purposes other than normal retirement, the Tax Code imposes an additional 10 percent tax on certain early distributions of these funds. Early distributions from a qualified retirement plan are also subject to federal income tax. However, if you are over age 59 ½ and your taxable income has fallen because of a job loss, the income tax you pay on the distribution could be offset by other deductions.

Distributions that you roll over to another qualified retirement plan or IRA are not subject to the 10 percent additional tax. Generally, you must complete the rollover by the 60th day following the day on which you receive the distribution.

Please contact our office if you have taken an early distribution from a qualified retirement plan or IRA. Besides the 60-day rollover window, there are special rules for military reservists, disaster victims and others.

FSAs. The current generous rules for using funds in a health flexible spending arrangement (FSA) may soon be a thing of the past. Congress is considering, as part of health care reform, placing tougher rules on health FSAs. For example, you could only use health FSA dollars for prescription medications with some exceptions and your maximum annual contribution to a health FSA would be limited to $2,500. These changes could be enacted before year-end but would not affect your FSA spending for 2009.

Depending on the terms of your health FSA, you may have to use your remaining health FSA dollars on or before December 31, 2009. This is known as the “use it or lose it” rule. Some plans allow for an extended period into 2010; for example, until March 15, 2010. If you have unused health FSA dollars, you should consider accelerating qualified purchases before year-end.

Congress. Finally, there is the added uncertainty of what Congress will do about many popular but soon-to-expire tax breaks. In addition to the ones we have mentioned, other incentives that will expire at year-end include the state and local sales tax deduction, the teachers’ classroom expense deduction, the higher education tuition deduction, tax-free distributions from IRAs for charitable purposes for individuals age 70 ½ and older, and national disaster relief. Many of these incentives are expected to be renewed for 2010 before year-end or in early 2010 with Congress making them retroactive to January 1, 2010. Our office will keep you posted of developments.

In this month’s Newsletter, we want to highlight the article FAQ: What’s New in Back-to-School Savings?  Many back-to-school college students and their families are facing the toughest time in years, in meeting the costs of higher education due to the recent economic downturn. In an attempt to face this challenge, Congress recently passed some tax relief for college students and families that, together with scholarships, loans and work-study grants, can provide an invaluable benefit this year. The tax relief is twofold: the new American Opportunity Tax Credit and more liberal withdrawal rules for Section 529 plans to cover technology needs. Both tax provisions are temporary - for 2009 and 2010 only - but likely will be extended in some form if the need continues.

American Opportunity Tax Credit

For 2009 and 2010, Congress has enhanced the Hope Scholarship Credit and has renamed it the American Opportunity Tax Credit. The 2009 Recovery Act makes the credit available to more families than the Hope Credit. Not only can the American Opportunity Tax Credit be used for the first two years of post-secondary education, but it is available for the third and fourth years of college as well. Further, the credit can be taken for more expenses, such as text books and course materials. And, although the credit phases out as adjusted gross income rises, the income phase out range has been increased. Additionally, 40 percent of the credit is refundable.

ABCs of the AOTC:

The American Opportunity Tax Credit (AOTC) is available for 2009 and 2010 up to a maximum of $2,500 per eligible student per year (100 percent of the first $2,000 eligible expenses plus 25 percent of the next $2,000 eligible expenses). The credit phases-out at higher income levels, making the credit available to more families as well. For single taxpayers, the phase out range is increased to $80,000 - $90,000 AGI, and for married joint filers the credit phases out when AGI falls between $160,000 - $180,000.

You cannot claim the above-the-line higher education expense deduction (of up to $4,000) in the same year that you claim the AOTC or Lifetime Learning Credit; you must choose among these tax benefits. If you have a choice between the AOTC and the Lifetime Learning Credit, or the higher education expense deduction, you may find that the AOTC garners you more tax savings. Although the credit will usually result in more tax savings, you should calculate the effect of the AOTC, Lifetime Learning Credit and higher education expense deduction on the tax return to see which achieves the greatest tax savings. Remember, also, in "doing the math" that the tax benefits are based on calendar tax years and not school academic years.

Technology expenses and Section 529 Plans

New for 2009 (and 2010) parents and students can take tax-free withdrawals from their prepaid tuition plans ("529 plans") to buy computers and computer-related equipment for college. The American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) added computers, computer equipment, technology, internet access and "related services" to the list of qualified higher education expenses that can be paid for with tax-free 529 withdrawals. However, as with the AOTC, this expansion is temporary and applies only for 2009 and 2010 ... unless Congress extends this new tax break.

Section 529 plan coverage

Qualified tuition programs, more commonly referred to as 529 plans, allow you to either prepay or contribute to an account set up for paying a student's qualified education expenses at eligible educational institutions. When withdrawals are taken to pay for qualifying education expenses they are tax-free. Qualifying expenses include tuition, fees, books, supplies and equipment required for enrollment or attendance of the student at an eligible educational institution (and expenses related to special needs services for special needs students). They also include expenses for room and board as long as the student is enrolled in a degree or certificate program at least part time. Now, thanks to the 2009 Recovery Act, they also include expenses for computers and computer-related equipment and services.

The types of computer and related technology and equipment that can be purchased with tax-fee withdrawals are fairly expansive. Expenses include those made to buy: computers, computer software, peripheral equipment, fiber optic cables related to computer use, as well as internet access and related services. The computer and/or computer-related must be used by the student or family members during enrollment in college (or other post-secondary institution).

Exceptions.  Tax-free withdrawals can not be taken for computer software designed for games, sports or hobbies, unless the software is "predominantly educational in nature."

Additionally, while the tax law allows you to combine the tax benefits of a 529 plan with one of the education credits or deductions, you cannot "double dip." That is, the expenses you use to compute the AOTC (or Lifetime Learning Credit) cannot also be included as a qualified higher education expense for purposes of determining your tax exclusion for 529 plan withdrawals.

Remember also that states have their own rules regarding education benefits, such as 529 plans and withdrawals. These must be considered as part of your education tax savings strategy.

Important Tax Due Dates/Deadlines

Date                            Instructions

10/15/2009                  Last day for individuals on extension to file previous year income tax return (Form 1040 series).

10/15/2009                  Deadline for undoing Roth conversion. If you converted from a traditional IRA to a Roth IRA in 2008, but for one reason or another want to undo the conversion, you have until October 15, 2009 to do that as well. Especially if the value of your investments in your IRA has dropped significantly since you converted from a traditional IRA to a Roth IRA, you may want to reconvert and then convert again at the lower value. This can save you from paying income tax on the amount by which your converted account has decreased.  Moreover, if you made a contribution to a traditional IRA or Roth IRA in 2008, but since determined that you should have contributed the money to the other type of account, you still can. If you act before October 15, 2009 you can recharacterize your IRA contribution.

11/30/2009                  First-time homebuyer tax credit.  The deadline for being entitled to the first-time homebuyer tax credit is fast approaching.

The credit sunsets after November 30, 2009. The 2009 Recovery Act raised the maximum credit to $8,000 for 2009. Individuals have until November 30, 2009 to make a first-time home purchase that qualifies for the $8,000 credit. A "purchase" for this purpose takes place when title closes (that is, at the "closing") and not when the contract of sale is signed. The credit is claimed on Form 5405, First-Time Homebuyer Credit.

August 28, 2009

TIGTA Report Recommends IRS Adopt Improved Project Management Process, (Aug. 21, 2009)

A recent audit report from the Treasury Inspector General for Tax Administration (TIGTA) has concluded that an improved project management process is needed to enable the IRS to measure the impact of its research efforts on tax administration. The report resulted from TIGTA's review of the IRS's process to (1) monitor the progress of projects, (2) validate results, and (3) measure the impact of IRS research efforts.

The overall aim of the review was to determine whether the structure and management of IRS research efforts can be improved when providing information to IRS executive management. The report noted that, although IRS management relies on research programs to provide information that is essential to improving performance on strategic goals and objectives, it has not developed and implemented effective business measures and project management processes to provide relevant data as to whether IRS research efforts attained established program goals. This is particularly important because the IRS spent more than $93.2 million on research in FY 2008 but cannot effectively assess the effect its research efforts had on tax administration.

http://prod.resource.cch.com/resource/scion/document/default/%28%40%40FTD01+20090821-T.1%2909013e2c8592438e

Registered Warrants Can Pay Your State Income Tax Bill

August 2009 - We accept California registered warrants (IOUs) as payment of current and past due personal and corporate tax obligations.To pay a tax liability with an IOU, the taxpayer endorses the IOU on the reverse side with the phrase "Pay to the order of Franchise Tax Board” and the taxpayer’s signature, then mail it with the tax bill or estimated tax voucher. By law, we cannot deposit the IOU until it is payable, but we will credit the taxpayer’s account on the date the IOU is received to stop the accrual of interest. If the IOU is not sufficient to pay the outstanding balance, the taxpayer should send an additional payment for the difference. Otherwise, the taxpayer will receive a bill reflecting the new balance due. On October 2, 2009, we will redeem the IOUs we receive with the Treasurer. If a taxpayer submits an IOU after October 2, we will deposit it and then credit the account with the face value of the warrant plus applicable interest. Taxpayers who want to receive the accrued interest from their IOUs must hold them until October 2, 2009, the date IOUs are redeemable.

State’s New Home Tax Credit Gone

August 2009 - We stopped accepting applications for the new home tax credit at midnight, Thursday, July 2, 2009. New tax law allocated $100 million of tax credits made available to approximately 10,000 qualified buyers who on or after March 1, 2009, and before March 1, 2010 purchased a qualified principal residence that had never been occupied. This credit is equal to the lesser of five percent of the purchase price or $10,000. The buyer must reside in the new home for at least two years immediately following the purchase date.

To ensure that enough valid applications were received to properly allocate the full $100 million available for this tax credit, FTB accepted 12,000 applications. However, we only issued approved credit certificates until the $100 million was exhausted. The credit was allocated on a first-come, first-served basis. The application, Form 3528-A, Application for New Home Credit, is no longer available on our website. However, the instructions for buyers to claim the New Home Credit, Publication 3528, on their tax return will be available no later than December 31, 2009.

IRS Offers Tips on Deducting Casualty and Theft Losses, Hobbies and IRS.gov, (Aug. 21, 2009)

http://prod.resource.cch.com/resource/scion/document/default/%28%40%40FTD01+20090821-I.1%2909013e2c8592438f

As part of its 2009 Summertime Tax Tips series, the IRS has provided summary sheets for taxpayers with important information on deducting casualty and theft losses, reporting hobbies resulting in profit and using the IRS website, www.IRS.gov.

In 2009 IRS Summertime Tax Tip 2009-17, the IRS provides the top 10 tips for taxpayers deducting casualty and theft losses. The IRS suggests that taxpayers who find themselves the victims of natural disasters or theft should know the rules for deducting their casualty losses when they file their 2009 federal tax return. Generally, taxpayers may deduct losses to their home, household items and vehicles. The tips provide specific guidelines that taxpayers must follow. Additional information is available in Publication 547, Casualties, Disasters and Thefts, which is available at www.IRS.gov or by calling 800-TAX-FORM (800-329-3676).

Summer is a time when many Americans take their fishing poles and gardening tools out of storage. Hobbies—such as woodworking, stamp collecting and scrapbooking—are often done for pleasure, but can result in a profit. If an activity makes a profit every year or so, there may be tax implications. Taxpayers are obligated to report income from almost all sources, including hobbies, on their federal tax returns. To help taxpayers determine whether their activity is a hobby or a business, the IRS provides eight questions that hobbyists should ask in 2009 IRS Summertime Tax Tip 2009-18. If an activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity. If the activity is a trade or business, the taxpayer may deduct ordinary and necessary expenses. More information about not-for-profit activities is available in Publication 535, Business Expenses, which is available at www.IRS.gov or by calling 800-TAX-FORM (800-329-3676).

The IRS reminds taxpayers in 2009 IRS Summertime Tax Tip 2009-19 that it is available at all times through its website at www.irs.gov. Taxpayers can use the website to obtain forms and answer tax questions. The tax tip also provides five specific reasons to visit the website. The IRS cautions that the genuine IRS website ends in .gov. Websites that end in .com, .net, .org or any other designations instead of .gov are not maintained by the IRS. The address of the official website is www.irs.gov.

Federal Tax Day, J.1 IRS's Determination to Proceed with Collection Activities Sustained (Stockton, TCM), (Aug. 20, 2009)

http://prod.resource.cch.com/resource/scion/document/default/%28%40%40FTD01+20090820-J.1%2909013e2c8591d5dc

The IRS's determination to proceed with collection against an individual was sustained. It was not an abuse of discretion for the settlement officer to conclude that a face-to-face hearing would not be productive. The individual failed to respond to opportunities for telephone and face-to-face hearings and waived his right to a face-to-face hearing.

Additionally, although no notice of deficiency was issued with respect to the Code Sec. 6702 frivolous return penalty assessed against him, the individual was precluded from raising the issue of the penalty before the Tax Court because he did not raise the issue or bring it to the attention of the settlement officer. Even if the penalty was susceptible to challenge on the merits, he failed to inform the settlement officer of any ground on which the frivolous return penalty should be set aside. Finally, the settlement officer verified that the requirements of all applicable law and administrative procedure were met and determined that the proposed levy action appropriately balanced the need for efficient collection of taxes with the individual's concerns that the levy be no more intrusive than necessary.

W.H. Stockton, TC Memo. 2009-186

August 13, 2009

For Many Small Businesses, Fall Filing Deadline Looms for

Special Refund Claims.

IRS Alerts Public to New Identity Theft Scams.

IRS Seeks New Issues for the Industry Issue Resolution

Program.

IRS Warns Taxpayers to Beware of First-Time Homebuyer

Credit Fraud.

IRS Seeks Public Comment for Proposals to Boost Tax Preparer

Performance Standards.

Recovery Rebate Credit Information Center.

Tax Relief in Disaster Situations.

Global News 
 
CRA Warns Canadian eBay Sellers to Declare: Canada’s Minister of National Revenue has Advised Canadians that the income they earn online is taxable.

HMRC Denies UK Tax Return Outsourcing Claims: HM Revenue and Customs, the UK tax authority, is said to be considering the option of outsourcing the processing of tax returns to foreign companies as part of efforts to cut costs, raising concerns over the privacy of sensitive taxpayer data.

Details of Italian Lending Moratorium Emerge: Italy’s Ministry of the Economy, the Association of Italian Banks and other interested industrial and commercial bodies have come together to arrange a moratorium on repayments of bank loans by small and medium-sized Italian companies.

China Axes Tax Breaks for Tobacco Advertising: Tobacco firms in China will no longer be able to deduct costs associated with advertising as a result of a recent edict issued in Beijing.


August 11, 2009 

IRS to Step up Tax-Exempt Fraud Enforcement

A report from the Treasury Department’s Inspector General for Tax Administration recommends that the IRS adopt a centralized approach to crack down on fraud at nonprofit organizations. The report found that the IRS’s Tax Exempt/Government Entities Division has made changes in the anti-fraud programs in its five offices, and more cases are being referred to the IRS Criminal Investigation for further investigation and to the Justice Department for possible prosecution. However, the effectiveness of the anti-fraud efforts varies by office, and one of the five offices is responsible for most of the referrals.

Still, the IRS has increased its efforts at combating fraud at tax-exempt organizations in recent years. While only 11 cases had been referred for possible criminal prosecution in fiscal years 2000 through 2002, 48 cases were approved in fiscal years 2006 through 2008. Of those 48 cases, 32 potentially represent about $37 million of additional revenue for the IRS. The TE/GE Division assessed $10 million in civil penalties and related assessments in just four of the cases. “The Tax Exempt Division has made significant progress in detecting and preventing fraud,” said TIGTA Inspector General J. Russell George in a statement. “However, the IRS should ensure that all of the division’s offices are effectively implementing anti-fraud programs. An effective anti-fraud program will provide greater assurance that the trust placed in tax-exempt organizations by taxpayers and the good work done by most of them are not tarnished.” The report recommended that the TE/GE Division develop and implement a uniform, division-wide approach with centralized oversight of its anti-fraud program and ensure that all TE/GE offices follow IRS procedures. The IRS agreed with TIGTA’s recommendations and plans to address them. (From WebCPA)

Offshore Accounts and Payments Gain IRS Attention

The IRS is increasing its audit activity involving payments to foreign persons and U.S. taxpayers’ offshore financial accounts. Businesses may be surprised by the review of payments, which will focus primarily on accounts payable to determine if any payments to foreign individuals or foreign companies should be subject to a 30 percent withholding tax. The agency’s focus on offshore financial accounts (primarily Swiss accounts with UBS) has been the subject of recent media attention. In connection with its ongoing investigation, the IRS is giving taxpayers an opportunity to avoid criminal prosecution by voluntarily disclosing unreported offshore accounts by Sept. 23, 2009 (recently extended to June 30, 2010 for some taxpayers).  

The first initiative, called the “accounts payable sweep,” focuses on a company’s vendor list and whether the company is properly withholding taxes on payments to foreign persons. In general, a payment to a foreign individual or a foreign company is subject to a flat 30 percent withholding tax. The IRS plans to scrutinize payments for directors’ fees, licensing fees, rents, royalties, interest, prizes, awards and services rendered by foreign individuals, professional services firms and corporations. The agency will also review payments made to foreign persons for dividends and interest.  The IRS has given its examining agents detailed procedures in its Internal Revenue Manual. Because the IRM is a public document, companies should be able to identify problem areas and take corrective action to reduce exposure, including putting procedures in place to comply with IRS requirements for offshore payments. 

The second IRS initiative focuses on U.S. taxpayers (individuals, companies, trusts, partnerships, and not-for-profits) that have not reported ownership, signature authority or control over offshore financial accounts. The IRS defines a “financial account” as any bank, securities, securities derivatives or other financial instruments account. The term includes any savings, demand, checking, deposit, or other account maintained with a financial institution or other person engaged in the business of a financial institution.

The IRS is giving taxpayers an opportunity to come forward voluntarily and disclose unreported accounts. The program enables taxpayers, who may have exercised poor judgment, to get into the IRS system without facing criminal charges. It imposes certain penalties and requires taxpayers to pay tax and interest on the unreported income.  As part of the voluntary disclosure program, the IRS looks back six years (2003-2008) and requires taxpayers to file or amend their income tax returns to disclose unreported income. The IRS will assess all taxes and interest due for the six years, plus an accuracy or delinquency penalty. Another penalty is added, equal to 20 percent of the highest aggregate account balance(s) for the six-year period.  In some cases, the voluntary disclosure program may not be the best option. For example, taxpayers who have properly reported and paid taxes on income from the offshore accounts, but failed to file the Form TD F 90.22-1, are advised by the IRS not to participate. Instead, the IRS explains that such taxpayers will not be penalized if they properly file Form TD F 90.22-1 and attach a statement explaining why the report or reports are late.

Given the complexity and potential hazards of voluntary disclosure, taxpayers are advised to consult an attorney specializing in international tax issues. (From Lewis B. Kevelson)

Tax Court Clamps Down on Vacation Home Treatments 

Washington -Just in time for the summer, the U.S. Tax Court denied the like-kind exchange treatment for vacation homes that are not strictly held for investment purposes. In a memo issued Wednesday, the court said that a Georgia couple's exchange of vacation homes did not qualify for the treatment according to Section 1031(a) of the tax code -- finding that the holding of any residence, even if motivated in part by an expectation that the property will appreciate in value, is insufficient to justify the classification of that property as being held for investment. “[T]he evidence overwhelmingly demonstrates that petitioners' primary purpose in acquiring and holding both the … properties was to enjoy the use of those properties as vacation homes; i.e., as secondary, personal residences,” the court wrote.

While the court said that it accepted as a fact that petitioners hoped that both properties they owned would appreciate, the court also said that, “The mere hope or expectation that property may be sold at a gain cannot establish an investment intent if the taxpayer uses the property as a residence. … Moreover, a taxpayer cannot escape the residential status of property merely by moving out.” The court also rejected the taxpayer's motion to reject the government's post-trial brief in the case.  Although the brief was filed one day outside of the 60-day period prescribed by its trial rules, the court said that it was the court that had erred in setting the brief’s due date.  The entire ruling, which is lengthy due to a variety of other, more routine legal questions, is available at www.ustaxcourt.gov/InOpHistoric/Moo8re.TCM.WPD.pdf. (from WebCPA)

General Tax Issues, Rules, and Concepts

Resident alien: generally taxed on income from all sources, including outside the U.S., at the same rates and in the same manner as a U.S. citizen. Alien is treated as a U.S. resident for any calendar year in which the individual:

1)      Is a lawful permanent resident of the U.S. at any time during such year.

2)      Elects to be treated as a U.S. resident.

3)      Satisfies the substantial presence test in the U.S. for at least 31 days during the calendar year and at least 183 days during the three-year period that includes the current calendar year and the preceding two calendar years.

Child or Dependant: a child or dependant is taxed on income. No personal exemption is allowed to an individual eligible to be claimed as a dependant on another taxpayers return. The standard deduction is limited to the greater of $850 or the sum of $300 plus earned income (up to the regular standard deduction for a single filer).

Exemption for Dependent: "qualifying child" or "qualifying relative," A person cannot qualify as a dependent if they file a joint return with a spouse for the same year. "Qualifying child" or "qualifying relative" must be U.S. citizen, national, or resident of the U.S. or a contiguous country. Anyone claimed as a dependent is barred from claiming another as a dependent.

"Qualifying Child"- four tests must be satisfied: relationship (child, stepchild, or descendant of such child, sibling, step-sibling, or descendant), age (must not have reached 19 by the end of the calendar year or a student 23 or younger (end of calendar year), principle place of abode (more than 1/2 the year), support (child must not provide more than one-half of their own support).

"Qualifying Relative"- individuals who fail qualifying child test can still be claimed as dependant if qualifying relative. Must pass four part test: relationship (several categories), gross income (must be less than $3,400), support (over one-half), dependency (cannot be qualifying child or taxpayer or any other taxpayer.

Additional Child Tax Credit

Up to $1,000 per child thru 2010. Qualifying child must not have attained 17 by the end of the year & must be U.S. citizen, national, or resident. Phase out starts at $110,000 for MFJ, $55,000 for MFS, $75,000 for single. Beginning in 2007, total amount of credit cannot exceed tax liability

Estimated Tax Payments (Fed & CA)

Due: April 15,    June 15, Sept 15, Jan 15

Penalty Proof: Fed: 110% of previous year tax liability. In general, 90% of an individual’s final current year’s income tax is to be paid through either w/h or estimated tax payments. 100% (110% if AGI in excess of $150,000) of the tax shown on the prior year’s return, or paying installments on a current basis under an annualized income installment method.

(CA: generally do not have to make est. tax pmts if CA w/h in each pmt period totals 90% of required annual pmt or if amount you owe w/ t/r is under $200 ($100 if married filing separately)).

Corporate estimated tax- 4/15, 6/15, 9/15, & 12/15-

If corporate tax is zero, the next year’s est. tax deposits must be based on that next year’s est. tax liability in order to avoid potential underpayment tax liabilities on next year’s return.

941 Payroll W/H Due

Paid either quarterly (<$2,500 for Q); monthly ($50,000 for Q) or semi-weekly (>$50,000 for Q) or daily (>$100,000 accumulated);

Jan 31: W-2 from previous year due.

941: filed last day of month following the end of the quarter

California Estimated Tax Payments

Search for “view payments” on FTB web site to verify est. tax payments received by the FTB.

Penalties

Federal-

IRC section 6651(a)(1) : The FTF penalty applies on the amount due from the return due date (or extended due date) until a return is filed or until the 25% maximum penalty rate has been applied. The FTF penalty rate is 5% a month.

The FTP penalty, for failure to pay amounts shown on the return as filed, applies on the amount due from the return due date to the date paid at ¹/₂% a month, not to exceed 25%.

RETIREMENT ACCOUNTS

Memo to Clients: If person is self-employed, and, as such, he cannot, in turn, employ himself! His "compensation" is, by definition, the net income reflected on his Schedule C each calendar year. A self-employed person's 401(k) deferral is computed by reference to their Schedule C net income, not by reference to a "salary". His computed deduction is taken on Page 1 of his Form 1040 and the related contribution is not even due until the due date, including extensions for his Form 1040 for the previous Plan Year. That means that he can make the total allowable contribution for himself on or before his tax return due date. The employer contributions, that is, the amounts that the employer contributes on behalf of his employees, are deducted on the employer’s Schedule C. His "salary" does not have to appear on Form DEE in order for all of this to be properly and beneficially designed and orchestrated.

ROTH IRA-

W/d are tax-free, as long as the account is at least 5 years old and you’re at least 59 ½ . No penalty for early w/d of contributions. No required w/d at 70 ½. Heirs can keep account after death of original owner of account and w/d by beneficiaries are also tax free. Contributions permitted if AGI under $95,000 (single) $150,000 (MFJ).

TRADITIONAL IRA-

Up front tax savings for those that qualify. All $that accumulates will be taxed when w/d’s begin. Minimum distributions must begin after 70 ½ years of age. 

CONVERSION TRADITIONAL TO ROTH

Must pay income tax on amount being converted. Available only if income is under $100,000, but new legislation will grant the privilege to everyone after 2010. In 2010 conversion to Roth is tax-free for 2010 (conversion tax deferred to 2011 & 2012).

SIMPLE IRA

Less than 100 employees, only retirement plan allowed for business, other business owned may have to be considered under plan, $9,000 limit in 2004, and $10,000 limit in 2005.

SEP IRA

Employees eligible if: 21 years old, employed 3 of preceding 5 years, pay greater than $450. Other owned business may need to be considered, maximum income limitations, traditional IRA's only, limit lesser of 25% of salary or $41,000 (in 2004). Employer contributions 100% vested immediately. Top-heavy consideration. Cannot have other retirement plans (generally).

401(k) PLANS 

Nondiscrimination standards must be met to maintain tax-favored treatment- set the limitations on the deferrals made by highly compensated employees which are based on the participation level of No Highly compensated employees. Failure to meet these standards results in either taxable refunds to the highly compensated employees of a portion of their deferrals or additional contributions made by the employer to the accounts of the non-highly compensated employees. Similar rules apply to employer contributions, if any.

ADP (Average Deferral Percentage) Test: IRS regulations require employee salary deferrals made under a non-safe harbor 401(k) plan do not discriminate in favor of highly compensated employees. If discrimination exists, the plan has one year to correct. Each participant’s deferral is divided by his salary for that year. Compensation limited to $225,000 in 2007 & $230,000 in 2008). The % is then averaged within the two groups. The disparity in these averages: 1) if the NHCE ADP is less than 2%, the HCE ADP cannot exceed twice the NHCE average. If the NHCE ADP is between 2% and 8%, the HCE average cannot exceed the NHCE ADP plus 2%. If the NHCE ADP is over 8%, the HCE average cannot exceed 1.25 times the NHCE ADP.

ACP Test (Average Contribution Percentage):

Maximum employee deferral is $15,500

Discrimination test: Highly Compensated Employees restricted to deferral % not to exceed 2% more than the deferral % for all Non-highly Compensated Employees (NHCEs). The company can make matching contributions, but, generally, is not required to make any contributions.

Safe Harbor 401(k) Plan: similar to a Traditional 401(k) Plan, with a few changes. The plan is not subject to a discrimination test (see above). In return, the company is required to make a 3% employer contribution or matching contribution of 100% of deferrals up to 4% of compensation every year to satisfy the Safe Harbor requirements. All employees eligible. Safe Harbor contributions are non-forfeitable. Maximum allocation to any participant is the lesser of $46,000 or 100% of his or her compensation. Employee deferrals count toward this limit. The maximum individual compensation for Plan purposes is $230,000. The maximum deferral limit is $15,500 with extra $5,000 after age 50.

DEFINED BENEFIT PLAN

No limitations on yearly contributions – if properly set up and implemented.

Health Savings Account-

Eligibility: must have:

1. Health coverage w/ annual deductible of not less than $1000 for single or $2000 for family coverage (for 2005),

2. No other health insurance plans,

3. You do not have Part A or B of Medicare

4. You can’t be claimed as dependent on another person’s t/r.

Contribution limits (2005): for individual, the annual deductible under the health insurance plan or $2,650, whichever is lower. For family coverage, the amount of the annual deductible under the health insurance plan or $5,250, whichever is lower.

Archer Medical Savings Account / Medicare Advantage MSA- Self-employed and small business use in conjunction with “high deductible” health insurance. IRA like accounts to defray unreimbursed health care expenses on tax-favored basis.

Form 1099-SA received at year end from financial institution to account for distributions from HAS, Archer MSA, or Medicare Advantage MSA

Cafeteria Plans

Employer-sponsored benefit packages that offer employees a choice between taking cash and receiving qualified benefits, such as accident & health coverage, group term-life insurance coverage, or coverage under a dependent care program. No amount from the plan is included in the employee’s income that chooses among the benefits of the plan. However, if cash is chosen, it is included in gross income as compensation.

Healthcare Flexible Spending Account (FSA) - traditionally have a “use or lose” rule, which has been eased recently.

Section 105 Plan– discuss with me.

EDUCATION CREDITS

Only one credit can be claimed per year.

Lifetime Learning Credit

Beginning on July 1, 1998, taxpayers may be eligible to claim a nonrefundable Lifetime Learning Credit against their federal income taxes. The Lifetime Learning Credit may be claimed for the qualified tuition and related expenses of the students in the taxpayer's family (i.e., the taxpayer, the taxpayer's spouse, or an eligible dependent) who are enrolled in eligible educational institutions. Through 2002, the amount that may be claimed as a credit is equal to 20 percent of the taxpayer's first $5,000 of out-of-pocket qualified tuition and related expenses for all the students in the family. After 2002, the credit amount is equal to 20 percent of the taxpayer's first $10,000 of out-of-pocket qualified tuition and related expenses. Thus, the maximum credit a taxpayer may claim for a taxable year is $1,000 through 2002 and $2,000 thereafter. These amounts are not indexed for inflation.

If the taxpayer is claiming a Hope Scholarship Credit for a particular student, none of that student's expenses for that year may be applied toward the Lifetime Learning Credit. The amount a taxpayer may claim as a Lifetime Learning Credit is gradually reduced for taxpayers who have modified adjusted gross income between $40,000 ($80,000 for married taxpayers filing jointly) and $50,000 ($100,000 for married taxpayers filing jointly). Taxpayers with modified adjusted gross income over $50,000 ($100,000 for married taxpayers filing jointly) may not claim a Lifetime Learning Credit. The modified adjusted gross income limitation will be indexed for inflation in 2002 and years thereafter. The definition of modified adjusted gross income is the same as it is for purposes of the Hope Scholarship Credit.

Hope Credit

The Hope Scholarship is a tax credit, not a scholarship. Tax credits are subtracted directly from the tax a family owes, instead of being subtracted from taxable income like a tax deduction. A family must file a federal tax return and owe taxes to get this tax credit. A family cannot get a refund for the Hope credit if it does not pay taxes. A family that owes less tax than the maximum amount of the Hope tax credit for which it is eligible can only take a credit up to the amount of taxes owed.

For the 2006 tax year, a family may claim a tax credit up to $1,650 for each eligible dependent for up to two tax years (100% of the first $1,100 and 50% of the second $1,100 paid for qualified expenses). The Hope credit is available only until each student's first two years of postsecondary education are complete

LIMITED LIABILITY COMPANY (LLC)

Partner’s Capital Account: a) tax basis b) GAAP c) Section 704(b) book.

LLC’s provide key financial benefits

A limited liability company consists of one or more members which may be individuals, partnerships, limited partnerships, trusts, estates, associations, corporations, other limited liability companies or other business entities. The members of a limited liability company are afforded limited liability similar to shareholders of a corporation and have pass-through taxes comparable to a partnership.

The owners, or members, have the personal liability protection that shareholders of a corporation do, with far less paperwork and fewer regulations. At the same time, the owners avoid the double taxation on profit to which shareholders in a regular corporation face. Those who aren't good candidates include existing regular corporations, also known as C corporations. And in California, some professionals such as lawyers and architects may not form an LLC. If you want to raise money from venture capitalists or by selling stock, an LLC probably is not the business form you need. Despite the potential benefits of an LLC, they have to be weighed against the cost, especially in California. Although it costs just $70 and takes a one-page form to set up a limited liability company in California, ongoing annual fees and taxes could cost more than 10 times that amount. There is a minimum annual tax of $800, payable to the state Franchise Tax Board. And once gross receipts hit $250,000, additional annual fees kick in, which range from $900 to $11,790. There have been several challenges to the constitutionality of the state's LLC fees, but the issue is still working its way through the courts. Limited personal liability protection does not apply if you personally guarantee a business debt or bank loan for the company. Then your personal assets are on the line. That will probably happen more often when a company is young and has not yet established its credit history. And as is the case with all other business entities, an owner can be held personally responsible for financial losses caused by their negligent or careless actions. Put enough money into the LLC to properly fund it. Otherwise, a court may not consider it a legitimate business and yank the personal liability protection. Separate personal expenses from LLC expenses. Aside from making good business sense that is another way to show that the company is legitimate, especially if you will be a single-member LLC. The limited liability format isn't available or appropriate for some business entities. In addition to a number of professions, banks, insurance companies and other financial service firms are not usually candidates for a limited liability company. And if you decide to end your California limited liability company, it must be formally dissolved.

California LLC

$800 LLC tax (annual fee) due beginning of the year (by April 15) for all CA LLC’s (or foreign LLC’s registered in CA); possible gross receipts fee due after filing tax return based on gross receipts reported on t/r.

Single Member LLC (filing requirement)

California tax return (Form 565) would need to be filed annually, but for federal purposes, no separate form or tax return is filed for a single-member LLC; the income is included in the member's individual income tax return (Form 1040) each year, usually on a separate Schedule C-Profit or Loss from Business [Sole Proprietorship].

PARTNERSHIP

A tax benefit of using a partnership over an S corporation is that partners can increase their bases in their partnership interests by their allocable share of partnership debts. (The same is true for a limited liability company with more than one member, unless it elects to be treated as a corporation, because it would be treated as a partnership for tax purposes.) The amount of partnership losses that can pass through to a partner to be used to reduce his or her income is limited to the partner's basis in his or her partnership interest (as increased for the partner's share of partnership debt). Thus, a partner's increased basis from his or her share of partnership debt allows more partnership losses to pass through to the partner.

PARTNERSHIP DISTRIBUTIONS

You inquired about the tax effect of a partnership paying a withdrawing partner for his share of accrued interest income.

Continuing with the example contained in your October 23 e-mail, Partner A is paid a liquidating distribution equal to his capital account of $105,000.  His capital account represents $90,000 of basis, plus $10,000 of unrealized gains, plus $5,000 of accrued interest.

I assume that the partnership is a cash basis taxpayer.  If it were an accrual basis taxpayer, the $5,000 of accrued interest would be includible on the partner's K-1 as his distributive share of partnership interest income.

A partnership is free to allocate partnership taxable income and deductions in accordance with any manner agreed upon by the partners, provided that the allocation has substantial economic effect.  That means that if the partnership has $5,000 or more of interest income, it is free to allocate $5,000 of taxable interest as Partner A's distributive share of partnership interest on his K-1.  Since the partnership paid the interest to Partner A, the allocation has substantial economic effect.  This means that the remaining partners will not be taxed on the interest income that was paid out to Partner A.

Partner A's K-1 will show $5,000 of interest income.  Partner A's capital account is still $105,000, but now it represents $95,000 of basis and $10,000 of unrealized gains.  Therefore, Partner A will recognize a capital gain of $10,000 from disposition of his partnership interest ($105,000 less $95,000).

So long as the partnership has made an IRC §754 election, the remaining partners will not be taxed on the $10,000 gain paid to Partner A.  The partnership assets tax bases will be adjusted for the $10,000 gain recognized by Partner A.

INVENTORIES

263A calculation: (2 methods) 1. Simplified Production Method of manufacturers and producers. 2. Simplified Resale Method for resellers.

Section 263A cost ratio - absorption ration for manufacturers and processors and the allocation ratio for resellers (retailers, wholesalers & distributors).

Under both ratios = Sec. 263A costs incurred during the year / Sec. 471 costs incurred during the year.

The amount of Sec. 263A costs to be capitalized for a FIFO taxpayer is calculated by simply multiplying the Sec. 263A absorption or allocation ratio times the year end FIFO inventory balance.

Greater tax deferral is achieved when Sec 263A costs are minimized.

Retailers need not capitalize Sec 263A costs if the averages of their past 3 year’s sales are less than $10 million

CORPORATE OVERVIEW

(Source BNA Tax Management)

1. Organization- tax free exchange results in substitution of basis

2. C Corporation Operations

3. Multiple Corporations

4. Corporate Distributions

5. Stock Dividend

6. Complete Liquidations

7. Taxable Sale of C Corporation

8. Tax-Free Reorganization- certain exchanges of stock result in a deferral of gain or loss: (7 types), a) Type A: statutory merger or consolidation. b) Type B: use of voting stock of acquiring corp. to acquire at least 80% of voting power and 80% of each class of nonvoting stock of target corporation. c) Type C: use of solely voting stock of acquiring corp. to acquire substantially all (90%of net assets & 70% of gross assets) of the target’s property. Target must distribute received consideration, and all other property under plan of reorganization. d) Type D: a transfer of part or all of its assets to another if immediately after the transfer the transferor corp, or its shareholder, control the transferee corporation (own 80% of the voting and each class of nonvoting stock). Generally results in a spin-off, split-off, or slit-up.) e) Type E: a recapitalization to change the capital structure of a single corp (e.g. bondholders exchange old bonds for new bonds or stock). f) Type F: a merge change in identity, form, or place of organization (e.g. name change, state of incorporation). g) Type G: transfer of assets by an insolvent corporation or pursuant to bankruptcy proceedings, with the result that former creditors often become owners of the corporation. Other issues 1) plan of reorganization 2) Continuity of Shareholder Interest 3) Continuity of business enterprise.

9. Corporate Divisions

10. Corporate Tax Attributes

Landmark Cases in Subchapter C Arena

S CORPORATION ELECTION

Per 1120S instructions for years ending after December 31, 2007, corporations may be able to make an election to be an S corporation by filing Form 2553 with Form 1120S. Form 2553 must be filed by March 15^th of current year to take effect in current year. Relief for late election is available.

S CORPORATION LATE ELECTION PROCEDURE- See attorney.

S CORPORATIONS

(From article on open account debts) S corporation shareholders are able manipulating their tax basis in so-called "open account debts" (loans by shareholders to the S corporation that are not evidenced by separate written instruments) to defer taxable income.

How it works: S corporation shareholders cannot increase their stock bases by their proportionate share of the S corporation's debts. Under Section 1367, S corporation losses that pass through to a shareholder are first applied against the shareholder's stock basis, and, once the stock basis has been reduced to zero, the losses are applied against the shareholder's basis in any loans he or she has made to the S corporation.

When a shareholder loans money to an S corporation, the shareholder takes a basis in the corporation's debt equal to the amount of the loan, called "debt basis." With open account debt, the shareholder calculates debt basis at the end of each year by netting advances and repayments into one debt basis. If debt is not open account debt (i.e., "single indebtedness"), the shareholder takes a separate basis in each advance, and the basis in each such advance is not increased by future advances. If the S corporation's losses exceed the shareholder's stock basis, the losses pass through to the shareholder up to the amount of the debt basis. The losses in excess of stock basis reduce the debt basis. Future income of the S corporation restores the debt basis before it increases stock basis. Repayment of debt in excess of the holder's basis in such debt results in taxable income.

Under these principles, as in Brooks v. Commissioner, T.C. Memo 2005-204, taxpayers have used an open account debt to defer taxable income by increasing open account debt basis at successive year ends to permit losses to pass through to them without having to recognize income from repayments of the advances. In that case, an S corporation shareholder borrowed money from a bank and advanced it to the corporation as open account debt at the end of year #1. The shareholder's debt basis allowed him to recognize S corporation losses for year #1 in excess of his stock basis. The losses reduced his debt basis. In early year #2, the corporation repaid the shareholder. To prevent taxable income from such year #1 repayment, and to allow him to recognize year #2 losses, the shareholder made a second advance at the end of year #2 with more money he borrowed from a bank. The second advance increased his debt basis sufficiently to cover both the beginning year #2 repayment of the year #1 advance and the year #2 losses. The shareholder repeated this pattern in the following year.

The IRS argued that the shareholder must determine his debt basis at the time of the repayment in early year #2 without regard to the advance at the end of year #2. Under the IRS's argument, the shareholder would have had a debt basis smaller than the repayment because the year #1 losses had reduced his debt basis. The shareholder would have had taxable income equal to the excess of the repayment over his debt basis. The shareholder successfully argued that he properly calculated his debt basis at year end, allowing him to net the repayment against the combined year #1 and year #2 advances. Consequently, the shareholder had sufficient debt basis to avoid taxable income from the repayment. If the debt had not been open account debt, the advances made later in the year would not have increased the debt basis, and the repayment of the debt would have triggered gain.

The proposed regulations would impose a $10,000 limit on open account debt. If at any day during the year, the net of advances and repayments exceed $10,000, the debt would cease to be open account debt on that day. The entire principal amount of the advances on the close of such day would be treated as single indebtedness. Future advances would not increase the shareholder's basis in the single indebtedness. Thus, a shareholder that exceeds the $10,000 limit would have taxable income when the S corporation repays the single indebtedness (that would no longer be treated as an open account debt) to the extent the repayment exceeds the shareholder's debt basis, reduced by the S corporation's losses, in the particular debt the corporation is repaying. Any future advances not evidenced by a written instrument would be treated as open account debt until such advances exceed the $10,000 limit.

The proposed regulations would be effective for advances to an S corporation made after the date of publication of the final regulations in the Federal Register and repayments on those advances by the S corporation.

PERSONAL SERVICE CORPORATION

Taxed at flat 35%. Does not apply for CA.

A corporation is a personal service corporation if it meets all of the following requirements:

1. Its principal activity during the “testing period” is performing personal services (defined later). Generally, the testing period for any tax year is the prior tax year. If the corporation has just been formed, the testing period begins on the first day of its tax year and ends on the earlier of: a) the last day of the tax year, or b) the last day of the calendar year in which its tax year begins.

2. Its employee-owners substantially perform the services in (1). This requirement is met if more than 20% of the corporation's compensation cost for its activities of performing personal services during the testing period is for personal services performed by employee-owners.

 3. Its employee-owners own more than 10% of the fair market value of its outstanding stock on the last day of the testing period.

Personal services include any activity performed in the fields of accounting, actuarial science, architecture, consulting, engineering, health (including veterinary services), law, and the performing arts

A person is an employee-owner of a personal service corporation if both of the following apply: 1. He or she is an employee of the corporation or performs personal services for, or on behalf of, the corporation (even if he or she is an independent contractor for other purposes) on any day of the testing period:

2. He or she owns any stock in the corporation at any time during the testing period.

Personal Service Corporations can use cash method regardless of the amount of gross receipts.

PERSONAL HOLDING COMPANY TAX

PHC are subject to penalty tax on undistributed PHC income to discourage taxpayers from accumulating their investment income in a corporation taxed at lower than individual rates. A corp is a PHC if 1) during any time in the last year, 5 or fewer individuals own more than 50% of the value of the outstanding stock directly or indirectly, and 2) the corporation receives at least 60% of its adjusted ordinary gross income as “personal holding company income” (passive income). PHC is taxed at ordinary corporate rates plus highest individual tax rate on undistributed PHC income. Self assessing on Sch PH. Avoided by distributing PHC income.

OF FOREIGN CORPORATIONS

U.S. shareholders of a foreign corporation that is a controlled foreign corporation (CFC) for an uninterrupted period of 30 days or more during the tax year must include in gross income its proportionate share of the CFC’s income (whether distributed or not).

ACCUMULATED EARNINGS TAX

Corps subject to this if they accumulate earnings beyond reasonable business needs in order to avoid s/h tax on dividends distributed. Not self assessing.

QUALIFIED PRODUCTION ACTIVITY INCOME

(See rev. proc. 2007-34)

Section 199 of the Internal Revenue Code provides a deduction for income attributable to domestic production activities. Section 199(a)(1) allows a deduction equal to 9 percent (3 percent for taxable years beginning in 2005 or 2006, and 6 percent for taxable years beginning in 2007, 2008, or 2009) of the lesser of (A) the QPAI of the taxpayer for the taxable year, or (B) taxable income (determined without regard to § 199) for the taxable year (or, for an individual, adjusted gross income).  Section 199(b)(1) limits the deduction for a taxable year to 50 percent of the W-2 wages paid by the taxpayer for the taxable year. For this purpose, § 199(b)(2)(A) defines the term W-2 wages to mean, with respect to any person for any taxable year of such person, the sum of the amounts described in

§6051(a)(3) and (8) paid by such person with respect to employment of employees by such person during the calendar year ending during such taxable year.

Section 199(c)(1) defines QPAI for any taxable year as an amount equal to the excess, if any, of the taxpayer’s domestic production gross receipts (DPGR) over the sum of the cost of goods sold (CGS) allocable to DPGR and other expenses, losses, or deductions (other than the deduction allowed by § 199) (deductions) that are properly allocable to such receipts. Section 1.199-4(b) of the Income Tax Regulations provides rules for determining CGS allocable to DPGR. Section 1.199-4(c) provides rules for determining the deductions that are properly allocable to DPGR or to gross income attributable to DPGR.

ESTATE PLANNING –

TRUSTS & GIFT TAX

Marital Deduction
an estate tax deduction allowed a surviving spouse of half of the value of the estate of the deceased spouse. Thus, the minimum value of the estate before there is a possible federal estate tax rises from $600,000 (the level where estate tax begins to be calculated and charged) to $1,200,000 at the death of the first spouse to die. In trusts which a married couple creates, they can agree that on the death of the first to go, the amount of the property which is given to the survivor is limited to the amount which will not be subject to federal estate tax, thus delaying some or all estate tax until the death of the surviving spouse. Such trust provisions should be written only by an attorney and with consultation with an accountant or financial adviser.

Unified Estate and Gift Tax
in federal estate taxes, the value of the estate plus gifts upon which no gift tax has been paid are combined to determine the assets upon which the tax is calculated. The estate tax "kicks in" at $600,000 for each deceased person. In larger estates an experienced accountant is virtually mandatory to determine the estate tax (if any) and prepare the tax return.

Estate tax
generally a federal tax on the transfer of a dead person's assets to his heirs and beneficiaries. Although a transfer tax, it is based on the amount in the decedent's estate (including distribution from a trust at the death) and can include insurance proceeds. Currently such federal taxation applies to the amount of an estate above $600,000, or as much as double that amount if the estate is distributed to a spouse. Some states have an estate tax, more commonly called an inheritance tax.

Gift Tax
The estate, gift, and generation-skipping transfer (GST) taxes form a unified transfer tax system on the transfer of property on death (estate tax), during life (gift tax), and on transfers that skip a generation (GST tax). The EGTRRA Act of 2001 prospectively repealed the estate and GST taxes for estates of decedents dying after 12/31/09 while retaining the Gift tax in modified form.

As of 2004, the estate and gift taxes no longer share a single applicable credit amount (formerly the unified credit). The gift tax applicable credit amount was raised to $345,800 (sheltering the first $1 million of a donor’s lifetime gifts) in 2002 and remains at this amount through repeal in 2010 w/o adjustment for inflation (sect 2505a). In 2004 the estate tax applicable credit amount increased to $555,800 and sheltered the first $1.5 million of a decedent’s estate (the applicable exclusion amount).

Federal tax on large gifts. Gifts to members of a family may be up to $10,000 a year to each plus an additional $30,000 accumulation of gifts is allowed tax-free. Several states also impose gift taxes. As with all tax questions, professional assistance in gift tax planning is vital.

Unified Credit Equivalent-

QPRT- Qualified Personal Residence Trust-

By Pass Trust-

Generation-Skipping Transfer Tax

This memorandum summarizes the general provisions of the generation-skipping transfer ("GST") tax.

Transfers Subject to the GST Tax

The GST tax is imposed at the highest estate tax rate, which is 55%.

The GST tax was enacted so that all family property would be subject to a tax (whether gift tax, estate tax or GST tax) at least once in each generation. Before the GST tax, it was possible to avoid a tax on each generation in one of two ways: (1) property could be transferred in trust to a child for life, after which the property would pass to the next generation (i.e., grandchildren) without additional gift or estate tax; or (2) property could be transferred directly from a grandparent to a grandchild (outright or in trust) subject only to a single estate or gift tax (a "direct skip"), avoiding taxation on the children's or "middle" generation. In general, the GST tax now applies to these two types of transfers.

Trusts for Children for Life

If you create a trust for your child's lifetime, you pay a gift or estate tax at the time of creating the trust (subject to your available exemptions and credits). At your child's death, the trust property incurs either estate tax (because the child has sufficient control over the trust to be considered its owner) or GST tax (whenever the estate tax does not apply) before the trust property passes to the next generation. The GST tax does not apply, however, if the property passes to someone in the child's generation, e.g., a sibling; in that case, the GST tax is deferred until the property passes to someone in a lower generation.

Direct Skip Gifts to Grandchildren

Property that you give directly to a grandchild is subject to an immediate GST tax in addition to any gift tax or estate tax. This GST tax is intended to duplicate the consequences if you gave the property to a child (rather than a grandchild) and your child in turn gave the property to your grandchild. In that two-transfer situation, two taxes would be imposed; consequently, the GST tax adds a second tax to gifts you make directly to your grandchildren.

Exceptions to the GST Tax

The exceptions to the GST tax include the following: (1) trusts created before 1985, including those trusts as extended by exercising powers of appointment; (2) most gifts that are exempt from the gift tax; and (3) transfers, up to a per-person lifetime total of $1,000,000, designated by the transferor as exempt from the GST tax by use of your "GST tax exemption."

Pre-1985 Exempt Trusts

The GST tax was enacted by Congress in 1986, and it is not applicable to trusts that were irrevocable and in existence on September 25, 1985 (the date on which the 1986 legislation was first introduced in Congress). Trusts in existence before this date are said to be "grandfathered" from the GST tax. This protection from the GST tax applies also to these trusts as they may be extended by exercising powers of appointment, which in some cases may permit these older trusts to be continued for several generations without tax.

Gifts Exempt from Gift Tax

The GST tax does not apply to gifts that are not subject to the gift tax, which include the following: (1) annual exclusion gifts of up to $10,000 per donee per year (although there are certain technical requirements for gifts in trusts to obtain this exemption from the GST tax), and (2) payments for tuition or medical care paid directly to the school, doctor, hospital, etc. You may make these kinds of gifts to or for a grandchild without paying any GST tax. For more information about the exemptions from gift tax, see our separate memoranda Gift-Giving Tips and Gifts to Minors.

$1 Million Lifetime Exemption From GST Tax

Each individual has a $1 million lifetime exemption from the GST tax, which may be applied to any combination of gifts during life and at death. For example, at your death you may leave up to $1,000,000 in lifetime trusts for your children. At your children's deaths, the trusts' $1,000,000 (plus any appreciation) may pass to your grandchildren without incurring a GST tax (and without estate tax). Thus, the $1 million exemption provides an estate planning opportunity because you might deliberately leave property in a lifetime trust for a child for tax reasons even if there are no non-tax reasons. In contrast, if you leave this $1,000,000 outright to your children, the $1,000,000 (plus any appreciation) would be included in the children's gross estates and would be reduced by estate taxes as it passes to grandchildren.

Miscellaneous GST Tax Issues

As noted above, gifts made directly to grandchildren are normally treated as "direct skips" and are subject to the GST tax. This rule does not apply, however, if you transfer property to a grandchild after the death of your child who is the parent of that grandchild.

The GST tax also applies to your gifts to or in trust for unrelated individuals. For this purpose unrelated persons belong to a generation determined by their age in relation to your age. A person who is 37-1/2 or more years younger than you is treated as being in your grandchildren's generation.

QTIP TRUST- This trust allows the surviving spouse to make use of the trust property tax-free. Taxes are normally delayed till the surviving spouse dies and the trust property is received by the final trust beneficiaries named by the first spouse.

            Divided into Exempt and Non-Exempt portions: The special or reverse QTIP election allows the original transferor (or his or her executor if the transfer is at death) of an inter vivos transfer of property to a QTIP trust to elect to be treated as the transferor of the QTIP trust for purposes of the GST tax.12 Because the transferor's identity will not change, the original transferor may allocate the GST exemption to the QTIP trust. A reverse QTIP election is irrevocable and must be made with respect to all of the property in the trust to which the QTIP election applies.13 Likewise, protective reverse QTIP elections may be made.

Estate planners should keep in mind the following planning and drafting tips when creating QTIP trusts. A reverse QTIP election should not be made to the entire QTIP trust if such election and subsequent allocation of the GST exemption would result in an inclusion ratio greater than zero. Instead, the QTIP trust should be severed into two trusts or the governing instrument should provide for the ab initio creation of an exempt QTIP trust equal to the amount of the transferor's GST exemption allocated to that trust and a non-exempt QTIP trust to which the GST exemption will not be allocated.

QUALIFIED DOMESTIC TRUST (QDOT)- When more than the amount of the personal federal estate tax exemption is left to a non-US citizen spouse by the other spouse, then a trust is used to postpone estate tax.

SIMPLE TRUST

This type of TRUST is required to distribute all its income currently, whether or not the TRUSTEE actually does so, and it has no provision in the trust instrument for charitable contributions. It is to be distinguished from a COMPLEX TRUST. A trust may be a simple trust in one year and a complex trust in another year. In the year in which the trust distributes its corpus, it loses its classification as a simple trust.

COMPLEX TRUST

A trust that is to be distinguished from a simple trust in the fact that it permits accumulation or distribution of current income during the tax year and provides for charitable contributions.

GRANTOR TRUST

Typically, a trust created by a single individual, in which the settlor retains the ability to remove funds at any time, is called a grantor trust. Such trusts are often created as an investment management vehicle -- at least during the life of the settlor. The term "grantor trust" also has a special meaning in tax law: a trust in which the Federal income tax consequences of the trust's investment activities are entirely the responsibility of the settlor or another individual who has unfettered power to take out all the assets.

GRAT

Electing Small Business Trusts

Electing Small Business Trusts (ESBT) were created by Congress in the Small Business Job Protection Act of 1996 (P.L. 104-188). For years beginning after 1996, an ESBT may qualify as an S corporation stockholder even if the trustee does not distribute all of the trust's income annually to its beneficiaries. The portion of an ESBT that consists of the S corporation stock is treated as a separate trust for tax purposes (but not for trust accounting purposes), and the S corporation income is taxed directly to that portion of the trust even if some or all of that income is distributed to the beneficiaries.

Special rules apply when figuring the tax on the S portion of an electing small business trust (ESBT). The S portion of an ESBT is the portion of the trust that consists of stock in one or more S corporations and is not treated as a grantor type trust.

CHARITABLE TRUSTS (Types)

·         Charitable Lead Trust- a trust that pays a fixed annuity or unitrust amount to a charitable organization for a fixed number of years. Upon termination of the payments, the remainder interest is transferred to a non-charitable beneficiary.

·         Remainder Annuity- This is a trust under section 664(d)(1) that pays a fixed dollar amount (not less than 5% but not more than 50% of the initial net fair market value of all property placed in trust), at least annually, to one or more beneficiaries, at least one of which is not a charitable organization, for life, or for a specific number of years (not to exceed 20). Upon termination of the payments, the remainder interest (valued at 10%) or more) is transferred to a charitable organization described in section 170(c), or qualified employer securities are transferred to an employee stock ownership plan.

·         Remainder Unitrust- This is a trust under section 664(d)(2) similar to a charitable remainder annuity trust, except that it pays, at least annually, a fixed percentage (not less than 5% but not more than 50%) of the net fair market value of the trust’s assets.

·         Pooled Income Fund- This is a trust under section 642(c)(5) created and maintained by a charitable organization described in section 170(b)(1)(A)(i)-(vi). Donors to the fund receive a lifetime income interest and the charitable organization receives the remainder interest.

• Other 4947(a)(2)- split-interest trust- Split-interest trust. A split-interest trust is a trust that: Is not exempt from tax under section 501(a); has some unexpired interests that are devoted to; purposes other than religious, charitable, or similar purposes described in section 170(c)(2)(B); and has amounts transferred in trust after May 26, 1969, for which a deduction was allowed under one of the sections listed in section 4947(a)(2). A split-interest trust is subject to many of the same requirements and restrictions that are imposed on private foundations.  

Tax treatment of charities and gifts to charity

In common law jurisdictions, charities generally enjoy tax exemption for their income, and donors generally enjoy tax relief for gifts to charity. Details vary, of course, from country to country.

In the United States, there are complex tax law differences between private and public charities.

Donations to charities in the United States are deductible for income tax purposes if the organization has exempt status from the Internal Revenue Service, usually under non-profit organization sec. 501(c)(3) of the tax code. Such organizations file a tax return by using IRS Form 990, which is monitored by watchdog groups like Charity Navigator to analyze their business practices. Any organization meeting the rules of section 501(c)(3) can be classified a charity in the US, including trusts, foundations and corporations.

US tax law also allows trusts that do not qualify as exempt under 501(c)(3) to get significant tax advantages if they are set up with specific provisions. These are called Charitable Remainder Trusts (CRT) and Charitable Lead Trusts (CLT). Charitable Remainder Trusts are so named because the remainder of the assets in the trust passes to a designated charity at the death of the grantor or one or more beneficiaries. A current tax deduction is given for the portion that is determined to be the expected amount the charity will receive in the future, which is called the remainder. During the lifetime of the primary beneficiary, a percentage of assets or a fixed dollar amount are paid to the primary beneficiary. There are two primary types of CRTs: Charitable Remainder Unitrusts (CRUT), where a percentage of assets is received by the lifetime beneficiary, and Charitable Remainder Annuity Trusts (CRAT), where a fixed dollar amount is received every year. Charities or other trustees are also allowed to set up pooled trusts that operate similarly to individual CRTs except that they receive contributions from multiple donors. This allows each donor similar benefits as an individual CRT without the expense of creating the trust themselves. The Charitable Lead Trust is essentially the reverse of a Charitable Remainder Trust. In this form, the lifetime payments go to the charity and the remainder returns to the donor or to the donor's estate or other beneficiaries. Thus the two types of CLTs are CLUTs and CLATs, which are analogous to CRUTs and CRATs.

Similarly named and often confused with CRUTs and CRATs are Grantor Retained Unitrusts (GRUT) and Grantor Retained Annuity Trusts (GRAT). The difference is that GRUTs and GRATs do not involve charitable beneficiaries and therefore are not given the charitable deduction.

charitable remainder unitrust is a charitable remainder trust created by 26 USCA 664. This trust ("CRUT") pays a fixed percentage of the assets in the corpus to the set beneficiary. The trustee determines the value of the assets by its fair market value at the time of contribution. The fixed percentage of the payout must be more than 5% and less than 50% of the fair market value of the assets in the corpus. The remainder of the corpus goes to the set charities. The remainder must be at least 10% of the fair market value of the asset when contributed. Section 664(d) defines a charitable remainder unitrust.

Under § 664(d) a charitable remainder unitrust is a trust that:

• (A) from which a fixed percentage (which is not less than 5 percent nor more than 50 percent) of the net fair market value of its assets, valued annually, is to be paid, not less often than annually, to one or more persons (at least one of which is not an organization described in section 170(c) and, in the case of individuals, only to an individual who is living at the time of the creation of the trust) for a term of years (not in excess of 20 years) or for the life or lives of such individual or individuals,
• (B) from which no amount other than the payments described in subparagraph (A) and other than qualified gratuitous transfers described in subparagraph (C) may be paid to or for the use of any person other than an organization described in section 170(c),
• (C) following the termination of the payments described in subparagraph (A), the remainder interest in the trust is to be transferred to, or for the use of, an organization described in section 170(c) or is to be retained by the trust for such a use or, to the extent the remainder interest is in qualified employer securities (as defined in subsection (g)(4)), all or part of such securities are to be transferred to an employee stock ownership plan (as defined in section 4975(e)(7)) in a qualified gratuitous transfer (as defined by subsection (g)), and
• (D) with respect to each contribution of property to the trust, the value (determined under section 7520) of such remainder interest in such property is at least 10 percent of the net fair market value of such property as of the date such property is contributed to the trust.

Charitable Remainder Annuity TRUST is a Planned Giving vehicle that entails a donor placing a major gift of cash or property into a trust. The trust then pays a fixed amount of income each year to the donor or the donor's specified beneficiary. When the donor dies, the remainder of the trust is transferred to the charity.

Charitable trusts such as a CRAT require a trustee. Sometimes the charity is named as trustee, other times it's a third party such as an attorney, a bank or a financial advisor.

Charitable Remainder Unitrusts and Charitable Remainder Annuity Trusts are exempt from federal income taxation if there is no unrelated business taxable income. Files Forms 1041A and 5227 (Fed) & 541 A & B (CA).

EXEMPT FOUNDATIONS

Pay federal tax (excise tax) of 2% of investment income.

Beginning in 2008, small tax-exempt organizations that previously were not required to file returns may be required to file an annual electronic notice, Form 990-N, Electronic Notice (e-Postcard) for Tax-Exempt Organizations not Required To File Form 990 or 990-EZ. This filing requirement applies to tax periods beginning after December 31, 2006.

Small tax-exempt organizations, whose gross receipts are normally $25,000 or less, are not required to file Form 990, Return of Organization Exempt from Income Tax, or Form 990-EZ, Short Form Return of Organization Exempt from Income Tax. With the enactment of the Pension Protection Act of 2006 (PPA), these small tax-exempt organizations will now be required to file electronically Form 990-N, also known as the e-Postcard, with the IRS annually.   Exceptions to this requirement include organizations that are included in a group return, private foundations required to file Form 990-PF, and section 509(a)(3) supporting organizations required to file Form 990 or Form 990-EZ.

The IRS will mail educational letters starting in July 2007 notifying small tax-exempt organizations that they may be required to file the e-Postcard.  The IRS is developing an electronic filing system (there will be no paper form) for the e-Postcard and will publicize filing procedures when the system is completed and ready for use.

The PPA requires the IRS to revoke the tax-exempt status of any organization that fails to meet its annual filing requirement for three consecutive years.  Therefore, organizations that do not file the e-Postcard (Form 990-N), or an information return Form 990 or 990-EZ for three consecutive years, will have their tax-exempt status revoked as of the filing due date of the third year.

If you would like additional information about this new filing requirement, including notification when the filing system is ready, or information about other new developments, subscribe to Exempt Organization’s EO Update, a regular e-mail newsletter that highlights new information posted on the Charities pages of irs.gov.

Fees Deductible by Estates & Trusts

Under current tax law, certain costs may be deducted in full if they're paid or incurred in connection with the administration of an estate or trust and wouldn't have been if the property weren't held in the trust or estate. But "the language is ambiguous," says Carol Harrington, a lawyer at McDermott, Will & Emery in Chicago. "When smart judges come to different conclusions, it's pretty clear the language is unclear."

Under the proposed regulations, the IRS essentially breaks down typical costs into those it considers to be unique to an estate or trust and those that aren't. Costs the IRS considers unique -- and thus fully deductible -- include fiduciary accounting, trust income or estate-tax returns, and communicating with beneficiaries. Expenses the IRS doesn't consider to be unique -- and thus subject to the 2% floor -- include standard investment advice as well as custody or management of property.

Many trust companies "bundle" all of their costs into one fee without breaking down the charge into component parts. Under the IRS regulations, if an estate or trust pays a single bundled fee, it must figure out how much of the fee would be fully deductible and how much wouldn't be.

Alternative Minimum Tax

Taxpayer is subject to AMT if tentative minimum tax is greater than regular tax. If subject to AMT, review preference and adjustment items to see if any can be postponed or eliminated.

            Preference (special provisions for regular tax that are not allowed for the AMT; i.e. state income taxes) & Adjustment (timing differences that arise because of differences in the regular and AMT tax calculations; i.e. depreciation differences): 1) standard deduction not allowed for AMT 2) personal and dependency exemptions are not allowed for AMT 3) medical expenses limited to 10% for AMT 4) itemized deductions- property tax, state income tax, other taxes not allowed for AMT 5) home equity debt deduction 6) miscellaneous deductions 7) itemized deduction phase out not required for AMT 8) depreciation calculations longer for AMT 9) NOL calculated differently 10) state income tax refunds not income for AMT 11) private activity bonds 12) other less common differences- stock options, oil/gas depletion, R&D expense, gains on sale of rental real estate, passive losses, small business stock gain.

            AMT tax rate: 26 (first $175,000 of AMT base) or 28% (15 or 15% for Capital Gains

            Accelerating state and local estimated tax payments made after the year end, to on or before the year end could generate tax savings due to increase in current year itemized deductions (being subject to AMT may reduce the benefit however).

Form 8801- Credit for Prior Year Minimum Tax

Calculate minimum tax credit, individuals, estates, or trusts, for alternative minimum tax incurred in prior tax years and to figure any minimum tax credit carryforward. Minimum tax credit is allowed only for deferral items (i.e. depreciation) not permanent differences in taxable income over time.  Credit can only be taken in year when you are not in the AMT.

Alternative Minimum Tax Calculation

1. Start with 1040 line 41 (not AGI)(AGI –itemized or standard deduction).
2. Add back personal and dependant exemption deductions.
3. Add back standard deduction) if you don’t itemize).
4. Add back state, local and foreign income and property-tax write-offs.
5. Add back home equity loan interest (if proceeds not used for home-improvement).
6. The AMT ignores some itemized deductions, such as investment expenses and employee business expenses, and some medical and dental expenses.
7. Add income the interest from private-activity bonds.
8. Add the "spread" between the market price and the exercise price of incentive stock options granted by your employer (the basis is then the higher, market price, value for AMT purposes)
9. Deduct refunds from state, local, and foreign taxes.
10. Miscellaneous items for business, rental properties or interests in partnerships or S corporations.
11. Deduct the AMT exemption (reduced for income above $150,000).
12. Result is subject to AMT rate: 26% on the first $175,000 ($87,500 for married couples filing separately) and 28% on the excess. If the AMT exceeds your regular tax, you have to pay the greater amount.

Minimum tax credit: allows you to claim a credit on your tax return in future years for some of the extra taxes you paid under AMT rules. For whatever reason, the tax rules say that exercising incentive stock options is one of the few things that qualify you for the credit. A credit can only be taken in a year when you are not paying AMT.

STATUTES OF LIMITATIONS

• Claim for Refund: 3 years after date you filed original return or within 2 years after you paid the tax, whichever is later. (Section 6511(a)). Bad debt/worthless security 7 years. Refund claim based on NOL carryback or general business credit carryback must be filed within 3 years of the due date of the return.
• Sue for Refund: first file claim w/IRS w/I above statute time, if the IRS disallows your claim or does not act within 6 months after you file your claim, you can take your claim to court. 2 years to file your refund suit after disallowance.
• Collection statute: 10 years after assessment or levy; add 6 months for bankruptcy.
• Notice of Assessment: 90 days
• Injured Spouse Allocation, form 8379, to have your portion of overpayment refunded to you. (Two year Statute).
• Generally 3-year statute for the IRS to audit a tax return (Section 6501(a) & Regulation 301.6501(a)-1(a).
• IRS must assess tax return within 3 years after tax return filed (six years if the taxpayer omits additional gross income of 25% of the amount of gross income.

No statute of limitation is no tax return filed or if IRS prepares the tax return.

CALIFORNIA COLLECTION OF TAX

I checked the interest rules, interest on deficiencies accrues daily at the federal rate from the due date of the tax (in this case 4/15/2005) until paid. No interest is charged from 45 days after the final audit review and the day the notice of proposed assessment is sent to the taxpayer. So if the auditor takes more than 45 days to send the notice of proposed assessment, no interest is charged after the 45th day until the notice of assessment is sent out.

If payment is made on the notice within 15 days, no interest is charged for the period after the notice is sent (if he pays by Feb 17th no interest will be charged after 2/2/2009).

Interest is suspended if the taxpayer files a timely return and the FTB fails to issue a notice stating that a taxpayer has an additional tax liability within 18 months following the later of the original due date or the date the return was timely filed (i.e. filed within the extension period). The suspension stops (and interest begins to accrue again) 15 days after the FTB sends the notice of additional tax liability. 

In this case, interest stopped accruing 4/15/2007 and has not been accruing since that time, but will begin again 2/17/2009.

PAYROLL TAXES:

FICA TAXES: actual FICA determined as follows: On the first $94,200 you earn in 2006, you pay 7.65% in FICA tax; this is for Social Security (6.20%) and Medicare (1.45%). On earning above $94,200, you pay for the Medicare portion only (1.45%).

Social Security tax W/H % = 6.2% (both employer & employee) maximum base- $94,200 (2006)

Medicare tax W/H = 1.45 (both employer & employee) with no maximum base

FUTA Tax = 6.2% on first $7,000 in wages (Employer only) (a credit for state FUTA taxes reduces federal FUTA to .8%)

Self-Employment Tax = 12.4% (Social Security, $97,500 maximum base); 2.9% (Medicare, unlimited base)

California

.8 % of SDI Wages (2008) (up from .6% in 2007); Max $83,389 (up from 2007 maximum of $83,389) (excess SDI refund Form 540); maximum SDI per employee = $693.58 (up from 2007 maximum of $500.33).

CAPITAL ASSETS

Personal use assets and investments (generally clothing, recreational equipment, personal residence, automobiles, vacant land). Losses from the sale or exchange of personal use assets are not recognized. Section 1221(a) defines what is NOT a capital asset

DEPRECIATION

Types of Assets

• 5/5 Computer Equipment
• 7/12 Video, photo, phono
• 7/10 Cell phone, telecom equip.
• 5/6 typewriter, calculator, copier
• 7/10 office furniture / farm equip.
• 5/9 Rental Furniture / farm equip
• 7/12 General Purpose tools / machine / equip
• 15/20 land improvements
• 27.5 / 40 Residential rental real estate
• 39/40 Non-residential real estate

Depreciation Type

MACRS

ACRS

Non-recovery property

Amortization

168(f)(1) election

Asset Class

3, 5, 7, 10, 15, 20, 25 yr.

Low Income Housing 18, 19 yr.

Residential Real Estate

Non-residential real estate

California Form DE-6 (quarterly employer filed return); DE-88 (payment voucher).

Depreciation Methods

200% Declining Balance

150% Declining Balance

Straight Line

Prescribed ACRS

Alternate Method

125% Declining Balance

MACRS Convention

Half- year, Mid-quarter, Mid-month, N/A

Pre-1987 asset

Section 1231 Classification

Applies to assets used for business & held for more than one year (not capital assets). 1231 property includes depreciable or real property used in business or for the production of income (machinery & equipment, buildings, and land), livestock, timber, coal, iron ore, unharvested crops, certain purchased intangible assets (patents and goodwill) eligible for amortization. Excluded property includes property held less than one year, nonpersonal use property where the casualty losses exceed casualty gains for the taxable year. Inventory and property held primarily for sale to customers, copyrights, musical compositions, accounts receivable.

Section 1245 Recapture

You cannot exclude from taxation any gains which are attributed to the depreciation you claimed after May 6, 1997.

Here's what recapture means. It means you have to pay tax on the gains that are attributed to depreciation. And these gains are taxed at 25%, not at the much lower long-term capital gains tax rates of 5% or 15%. This is explained in IRS Publication 523, Selling Your Home, in the section entitled Business Use or Rental of Home and in particular the section on "unrecaptured section 1250 gain" (links to IRS Web site).

The ACE depreciation adjustment

The adjusted current earnings (ACE) adjustment may have been simplified by the Revenue Reconciliation Act of 1989 (RRA 89), but the adjustment process is still complex. The Tax Reform Act of 1986 required an adjustment based on ACE to replace the corporate book income adjustment for tax years starting after 1989. The regulation meant that corporations' alternative minimum taxable income (AMTI) generally increased by 75% of the amount by which ACE was greater than the AMTI. RRA 89 was intended to change the corporate alternative minimum tax by simplifying the way in which ACE depreciation was calculated. The complexity of the calculation is demonstrated through several examples.

In computing alternative minimum taxable income (AMTI) for tax years beginning after 1986 and prior to 1990, one-half of the amount by which the corporation's pre-tax book income exceeded AMTI, determined without regard to the "book income adjustment" and any NOLs, was added to the otherwise computed AMTI. TRA 86 provided that for tax years beginning after 1989, the corporate book income adjustment would be replaced with an adjustment based on adjusted current earnings (ACE). Hence, most corporate taxpayers must compute ACE for tax years beginning after 1989. In general, AMTI is increased by 75% of the amount by which ACE exceeds AMTI, determined without regard to the ACE adjustment and any NOLs.

The Revenue Reconciliation Act of 1989 (RRA 89) subsequently made a number of significant changes to corporate AMT. One purpose of RRA 89 modifications was to "simplify the ACE computation." This article examines the changes in the computation of ACE depreciation and provides examples of required computations. It also deals with portions of the proposed regulations under Sec. 56 issued in May 1990. The computations presented in this article suggest that ACE depreciation adjustments may be larger than many taxpayers have anticipated. Indeed, the magnitude of the adjustment for five-year ACRS property in the last year of its regular tax depreciation life can be staggering (see Example 3). The ACE depreciation adjustments may generate unexpected AMT liabilities, and corporate taxpayers are well advised to review their estimated tax payments to avoid significant interest and underpayment penalties.

UBTI (Unrelated Business Taxable Income) 

The UBTI related Code and Regulation Sections do indeed apply to Individual Retirement Accounts. Since there are no ordinary filing requirements by an IRA Trust itself, no accounting work is typically required, and the IRA Holder, again typically, does not him or she have to be on the lookout for rogue information/forms that may require some sort of esoteric tax related filing.

I state the above in the manner I did because it is the responsibility of the Fiduciary for an IRA to identify UBTI and, when the UBTI is $1,000 or more in a given year, to file the related Form 990-T [Exempt Organization Business Income Tax Return (and proxy tax under section 6033(e))]; that would be Charles Schwab.

The IRA Trust must actually obtain an Employer Identification Number for purposes of filing Form 990-T and the Form requires certain "codes" and other information that an outsider would not ordinarily have. So, it’s a bit of work. Perhaps, once Schwab is given a heads-up by you, they will jump right on in and prepare the Forms 990-T for calendar years 2004, 2005 and 2006 (all are now delinquent)

CALIFORNIA State Items

No sales tax on RV’s, planes, yachts if kept out of state for 90 days.

CA requires companies to withhold payments to non-residents for services performed as an independent contractor in California, (2) rents or royalties on assets such as commercial real estate, wells, mines, and equipment located in CA, (3) distributions from CA estates and trusts. W/H rate is 7% of gross amount of CA payment. Exceptions include: payment for goods, to residents of CA, payments of less than $1501, payments to exempt organizations, other exemptions.

Subject: Selling (foreclosure) of Home for Less than Cost/Mortgage Balance:

If you transfer title on your home, whether voluntarily through a warranty deed or grant deed, or involuntarily through foreclosure, you have sold your home. You might be subject to taxes, even if you sold your home at a loss, either on a short sale or by foreclosure.

Capital losses can be offset against capital gains, but in the absence of capital gains, the yearly cap is $3,000 ($1,500) FOR MFS) on the amount of losses that can be offset against ordinary income.

The IRS tax rules for foreclosures or repossessions by lenders of homes of owners who have fallen behind on mortgage payments with no equity - cancellation (forgiveness) of debt - is reportable income (unless insolvency applies).  

Upon foreclosure, if the bank cancels the loan for less than the balance of the loan, the forgiven amount is income reported on Form1099-A (1099-C).

But the Mortgage Forgiveness Debt Relief Act of 2007, creates a 3-year window (1/1/07 to 01/01/10) for homeowners to refinance their mortgage and pay no taxes on any debt forgiveness (mortgage must be purchase money mortgage not refinance, home must have lost value or owner must have financial distress, priciple residence only.)  Reduces basis to amount of excluded debt.

STOCK OPTIONS

Qualified (Statutory) or Non-Qualified (Non-Statutory) stock options (most Employee Stock Options are Qualified)- a Non-Qualified option is taxed when granted if option has "readily ascertainable market value" at that time (if not traded on established market, probably do not have readily ascertainable market value. If no readily ascertainable market value the exercising of the option is the taxable event. Ordinary income is recognized.

Qualified Options: two kinds (1) Incentive Stock Options and (2) options granted under employee stock purchase plans. Usually only exercisable by individual granted the option. Income recognized upon exercising the option.  

If reported on Form W-2, this amount is usually the income recognized.

LOS ANGELES BUSINESS LICENSE

Small Business Exemption threshold is $100,000 in 2007: timely files w/ gross receipts less than this pay no tax. Prior to 2007, exemption amount depends on type of business.