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Last Updated:
Tuesday January 29, 2008

Local communities for which we provide CPA, accounting, tax preparation and business consulting services:

INDEX

• Tax Highlights for 2006

• Special Tax Bulletin for 2006

• Your Life Insurance Policy May Be A Gold Mine!

• Tax Highlights for 2005

• IRS Audits S Corporations

• Tax Highlights for 2004

• Tax Highlights for 2003

• Special Bulletin - July 2003

TAX HIGHLIGHTS FOR 2006

New tax legislation during 2006 included The Tax Increase Prevention and Reconciliation Act (TIPRA) of May 17, 2006, The Pension Protection Act of 2006 (PPA) of August 17, 2006, and The Tax Relief and Health Care Act of 2006 of December ¬¬20, 2006.

In September, 2006 I drafted a Special Tax Bulletin for 2006 covering certain provisions of the PPA; notably new rules for charitable donations and pension reforms. If you would like a copy of the Special Tax Bulletin, please contact me, or view it under Breaking News on my website at www.llrcpa.com.

TAX PLANNING FOR THE REST OF 2006

You finally have a good fix on what your taxable income and expenses are shaping up to be for 2006 and for several months into 2007. This allows you to effectively use acceleration or deferral techniques to maximize you overall tax savings between 2006 and 2007. Of course, this requires information gathering and a proactive approach. Some of the more frequently used strategies include:

• Smoothing out taxable income between 2006 and 2007 by accelerating and postponing transactions that either produce income or yield deductible expenses;
• Matching long and short term capital gains with losses to lower overall capital gains tax and possibly maximize the $3,000 amount of capital losses that can offset other income
• Bunching deductible expenses into one or the other year depending upon whether the standard deduction may be taken in one of the years, or whether the adjusted gross income limits for medical (7.5%) or miscellaneous itemized deductions (2%) may be more easily met. Strategies for accelerating expenses into the current year include:
  • Paying state and local income taxes or real estate taxes before the end of the year;
  • Paying your January mortgage payment in December;
  • Making next year’s charitable contribution in the current year.
• Maximizing the tax law limits on annual contributions to your retirement plan accounts, since one year’s limits cannot be added to the next year’s when not taken in time
• For businesses, taking advantage of the full $108,000 expensing deduction for 2006 and the $112,000 deduction available for 2007, and
• If you’re an S corporation shareholder, making certain that your stock basis is high enough to entitle you to any available losses.

INDIVIDUAL TAX CHANGES FOR 2006

Personal exemptions. The law provides for a 5-year phase-in of the repeal of the personal exemption phase-out – meaning in plain English that personal exemptions previously lost to high income taxpayers are being restored. In 2006 (and 2007) 1/3 or $1,100 of each exemption can now be used by the ‘wealthy’.

Credit for energy-efficient improvements to a personal residence by a homeowner. During 2006 and 2007 taxpayers can receive a tax credit for certain energy efficient purchases for the primary residence. The credit is a certain percent of the cost of the purchase subject to a maximum credit for all taxable years of $500 – no more than $200 of the credit can be attributable to expenses for windows. The following expenses are eligible: insulation systems that reduce heat loss/gain, exterior windows including skylights, exterior doors, and certain metal roofs.

In addition, credits for costs relating to residential energy property expenses are: $50 for each main air circulating fan, $150 for each qualified natural gas, propane, or oil furnace or hot water heater, and $300 for ‘energy efficient building property’, which includes electric and geothermal pumps and central air conditioners.

If placed in service in 2006 and 2007, solar, photovoltaic or fuel cell equipment qualifies for a 30% nonrefundable credit. An annual credit limit of $2,000 per category is set for solar hot water and photovoltaic expenditures, and $500 for each half kilowatt of capacity of qualified fuel cell property. (Not available for swimming pools and hot tubs.)

Charitable contributions.
Charitable contributions of IRA proceeds. For 2006 and 2007 only, a taxable required minimum distribution (for persons age 70-1/2 or more) from a traditional or Roth IRA may be excluded (up to $100,000) from income if the distribution is made to a qualified charity by the IRA trustee. The regular charitable substantiation rules apply. A charitable deduction may not be claimed.

Tax tip: Reasons to utilize this provision: You do not need to take the IRA distribution and do not want to pay the tax on it; many AGI related phase outs are reduced; perhaps the gift from the IRA will be a better choice than the gift of appreciated stock – since the IRA produces income to the estate of the account owner, leaving stock rather than the IRA may result in less tax to the beneficiary.

Vehicle donations. The deduction is limited to the actual sales price of the vehicle by charity. Form 1098-C is used by the charity and donor as an acknowledgement. If the vehicle is used by the charity the deduction is based on fair market value from a private party sale pricing guide, not Kelly Blue Book. (For a full explanation, see Tax Highlights for 2004).

Health Savings Accounts (HSA). Conceptually, the HSA is an individual retirement account for medical expenses. Earnings are generally exempt from tax. Favorable above-the-line deductions are available to individuals and self-employed persons. The plan works best for healthy, younger persons or families, who currently do not incur large medical expenses. They will be able to fund an HSA for use in later years when their medical bills will probably be greater and at the same time reduce current year outlay for medical insurance costs. The plan may be attractive to small employers who are looking to control the exponential rise in insurance premiums for employees. Distributions from the HSA are tax-free, provided the distributions relate to qualified medical expenses of the account beneficiary or family members. The rules are complex. You may contact me for further information or find information at www.msabank.com  or www.hsainsider.com.

Section 529 Qualified State Tuition Programs. The PPA permanently extends the Section 529 provision that makes qualified distributions used for higher education costs tax free. For more information see www.collegesavings.org and www.savingforcollege.com.

Gift tax annual exclusion increases to $12,000 for 2006 for transfers of present interests in property to any one donee.

Cost Segregation Studies (CSS). A cost segregation study is a valuation process that separates business personal property, and shorter-lived business real property improvements from the 27-1/2 year and 39 year building. The CSS provides deductions sooner. For example, each $100,000 reclassified from 39 year property to 5 year property is approximately a $20,000 net present value savings!

Even if the property was acquired in a prior year, a CSS may, in addition to increase the current and future amount of depreciation, allow you to take catch up deductions in the current year for depreciation not claimed in prior years. No need to file amended returns, worry about the statue of limitations for prior years, or pay for a letter ruling, as this change in method of accounting is free and automatic.

Page 3
To obtain a CSS requires payment of a fee to a preparer with knowledge of both the construction process and the tax law involving property classifications for depreciation purposes. You may want to look at www.bedfordcap.com, the site of Bedford Capital Consulting, one of the nation’s leading providers of engineering based cost segregation studies. There are tax pros and cons to cost segregation studies that are not easily described in these Tax Highlights. If you believe a CSS may have value, you should contact your tax advisor.

BUSINESS TAX CHANGES FOR 2006

Domestic Production Deduction (Code section 199)
If your business qualifies for the Domestic Production Deduction, this is a HUGE benefit. Be sure to read the rest of my comments on this matter.

Your possible deduction is 3% of the lesser of 1) qualified production activities income, or 2) taxable income. The deduction is limited to 50% of W-2 wages. The percentage increases to 6% for 2007, 2008, and 2009. For years after 2009 the deduction is increased to 9%.

Who qualifies for the deduction? 1) The manufacture, production, growth, or extraction in whole or significant part in the United States of tangible personal property (e.g. clothing, goods, and food), software development, or sound recordings 2) Any ‘qualified film’ produced by the taxpayer 3) U. S. production (but not transmission or distribution) of electricity, natural gas or potable water 4) Construction of substantial renovation of real property in the U.S. including residential and commercial buildings and infrastructure such as roads, power lines, water systems and communications facilities 5) Engineering and Architectural services performed in the U.S. and relating to construction of U.S. real property 6) In general, income from a lease, rental, license, sale, exchange, or other disposition of software developed in the U.S. qualifies for the deduction, regardless of whether the customer purchases the software off the shelf or takes delivery of the software by downloading the software from the Internet. Computer software is not limited to software for computers and includes, for example, video game software. Computer software does not include any data or information base unless it is in the public domain and is incidental to a computer program.

Additional businesses that qualify: Toy manufacturer, wholesale bakery, shopping center builder, kitchen contractor, film producer, optical lab (to the extent it ‘manufactures’ eye glasses), dental lab making crowns and dentures, winery, painting as part of construction, landscaping as part of construction of building, tax software writers.

Wholesale qualifies: Food or beverages prepared at the facility and sold at wholesale are not considered prepared at a retail establishment and the taxable income related to the wholesale transactions is therefore eligible for the deduction. If you have both wholesale and retail sales, the wholesale portion qualifies.

Businesses that don’t qualify: retail toy store, retail bakery, shopping center landlord, appliances sales, ophthalmologist, dentist, liquor store, house painter doing painting/repairs, landscaping for existing building, tax preparers.

There are numerous definitions and limitations and options to calculate costs. The list of qualified business shown above is not a complete list. It is my impression that this deduction is too good to pass up. If you believe your business may qualify, you should contact your tax preparer for an evaluation.

Credit for builder of energy efficient home. An eligible contractor who constructs a qualified new energy efficient home may qualify for a tax credit of up to $2,000. The contractor will need to verify that the home is used by the purchaser as a residence and will probably need some sort of a letter from the home buyer certifying the use.

Deduction for energy-efficient property expenditures by a commercial building owner. A new deduction is available for property placed in services in 2006 and 2007 for the cost of energy-efficient property expenditures for commercial buildings. Expenditures include interior lighting, heating, cooling, ventilation, and hot water, and the ‘building’ envelope. The deduction is a dollar amount per square foot.

To obtain these advantages, a Certification from an engineer-type is required.

There are many ramifications to these Energy Tax Incentives, so be sure to consult with your tax advisor.

Section 179 expensing for business personal property is $108,000 in 2006 ($112,000 in 2007) phasing out for costs in excess of $430,000 ($450,000 in 2007)
Special section 179 rules for automobiles:

1. Automobiles of 6,000 pounds or less are considered ‘passenger automobiles’, have a limited depreciation deduction and section 179 expensing is not allowed.
2. Certain trucks and vans (including SUVs and minivans built on a truck chassis) weighing 6,000 pounds or less are subject to depreciation caps slightly higher than for ‘passenger automobiles’ and section 179 expensing is not allowed.
3. Sports utility vehicles, certain trucks and certain vans with a loaded gross vehicle weight over 6,000 pounds and up to 14,000 pounds are exempt from the depreciation caps. Section 179 expensing is limited to $25,000. The $25,000 limit also applies to exempt trucks with an interior cargo bed length of less than six feet and exempt passenger vans that seat fewer than ten persons behind the driver’s seat.

Rollovers from retirement plans to Roth IRAs
For distributions in 2006 and 2007, you must roll your pension amount to a traditional IRA and then roll the traditional IRA amount to a Roth IRA. Taxable income results from the rollover.

Effective after 12-31-07 the PPA allows distributions from tax-qualified retirement plans, tax-sheltered annuities, and governmental 457 plans to be rolled over directly from such plan to a Roth IRA. Taxable income results from the rollover (except to the extent it represents a return of after-tax contributions), and the 10% early distribution tax does not
apply.

IRA provisions. The 2006 IRA contribution amount is $4,000 and an additional $1,000 catch-up contribution is permitted for those 50 and over, up to the individual’s compensation if neither the individual nor the individual’s spouse is an active participant in an employer-sponsored retirement plan. A homemaker who does not work outside the home may make a similar contribution if the combined compensation of both spouses is a least equal to the contributed amount.

If the individual or spouse is an active participant in an employer-sponsored retirement plan, the deduction limit is phased out based on AGI over certain levels.

Tax tip: Higher income taxpayers not able to contribute to a traditional or Roth IRA because of AGI limits may want to contribute to a nondeductible IRA. Then, in 2010, you will be able to convert that nondeductible IRA into a Roth regardless of your high AGI and there will be little tax at the conversion since you have a basis in the IRA. Only the earnings on the nondeductible IRA will be taxable; in addition, the tax can be spread over the following 2 years, 2011 and 2012. But if the person has other IRAs, there is an ‘ordering rule’ on basis and the results will not be as attractive as for a person who only has a nondeductible IRA.

Is a One Person 401K Plan better than a profit sharing plan?
Even though the Profit Sharing Plan limit has increased to 25%, sole proprietors might consider a single participant 401(k) plan. In order to contribute $44,000 to a Profit Sharing Plan in 2006, a sole proprietor must have $229,500 of net self-employment income However, a self-employed individual only needs $153,150 of net self-employment income in order to contribute $44,000 to a single participant 401(k) plan.

A Solo 401(k) plan is available to businesses whose only employees are the owner and the owner’s spouse. If the taxpayer is 50 or over, he or she can contribute an additional $5,000. Form 5500 is required for a 401(k) plan. (Schwab does not charge a fee for the 5500 preparation I understand.) A plan participant can borrow from the plan; strict rules apply. More information is available from www.401khelpcenter.com.

Leveraged gift to a child with low AGI. A saver’s credit for low income persons is now permanent. If you are over 18 and not a full-time student or claimed as a dependent on another taxpayer’s return, you are eligible. The maximum annual contribution eligible for the credit is $2,000. The credit rate depends on AGI.

Example: Son earns $15,000. His AGI is also $15,000. Father gives son $2,000 to contribute to his Roth IRA. Son makes the Roth IRA contribution and also gets a $1,000 tax credit (50% of the contribution, based on AGI) on his tax return. Father has given son $2,000 for a retirement contribution and also has enabled his son to spend or save $1,000 now.

EXTENDERS

Tax provisions scheduled to expire 12-31-05 were approved by the House and Senate on December 8th and 9th, and subsequently signed into law by President Bush just before Congress adjourned for the year. Provisions extended retroactively to 1-1-06 are:

Deduction for state and local taxes. Mostly benefits residents in states without income tax. Also, loading big-ticket sales tax purchases into 2006 may make sense for those able to take advantage of the optional sales tax deduction. Or, you could defer any state income tax payments into 2007.

Higher education tuition deduction. For 2006 and 2007, a $4,000 or $2,000 (based on AGI) above-the-line education deduction is available to single taxpayers. But only for higher education tuition and qualifying fees. The student claiming the deduction cannot also claim the HOPE of Lifetime Learning credit. Taxpayers may want to estimate AGI for 2006 and if it is within the cut-off for taking the deduction, pay spring tuition in December.

Teacher’s classroom expense deduction. Teachers and other education workers can deduct, above the line, up to $250 of certain out-of-pocket classroom expenses.

Research tax credit is extended to amounts paid or incurred in 2006 and 2007.

Leasehold and restaurant improvements. The new law extends the 15-year recovery period for certain leasehold and restaurant improvement through 2007. In case of a restaurant, more than 50% of the building’s square footage must be devoted to the preparation of and seating for on-premises consumption of, prepared meals and the improvements must be made to a building that has been in service for at least 3 years.

TAX CHANGES FOR 2007

Stricter rules for contributions of clothing and household items effective beginning in 2007. The deduction for these items will be allowed only if they are in good used condition or better. Therefore, used socks and used undergarments, etc. will be denied, as they have minimal monetary value.

Tax tip: Consider taking photos or preparing a more detailed description of the items gifted. No longer acceptable are the pink or yellow receipts from Salvation Army or Goodwill that say “3 boxes and 4 bags”.

Substantiation requirements for contributions modified effective beginning in 2007. Cash contributions regardless of amount cannot be deducted unless you have a receipt or canceled check. In other words, cash contributions to the ‘church collection plate’ will not be allowed unless you have a bank record or written communication from the donee that shows the name of the donee, date of contribution, and amount. Other written records are not sufficient.

Notification requirement for exempt entities not currently required to file an annual information return due to gross receipts under $25,000, must furnish the Secretary annually, in electronic form, various information about the organization. Failure to provide the required notice for three consecutive years will result in revocation of the organization’s exempt status.

Fixed contribution limitations on IRA accounts will be inflation adjusted to $156,000 (formerly $150,000) for married filing jointly and $99,000 (formerly $95,000) for most others.

Inflation adjustment of the Saver’s Credit for lower income taxpayers means higher income levels will qualify.

California minimum wage increases to $7.50 an hour (and to $8.00 1-1-08). This will have an impact on exempt executive, administrative and professional employees whose minimum salary requirements are tied to the minimum wage.

Planning opportunities to owners of rental property. Consider taking advantage of up to $25,000 in passive losses, limiting the number of days that a vacation home is rented, investing in low-income housing or rehabilitating older buildings, renting a dwelling unit to a family member, disposing of unwanted property in a tax-free exchange, and depreciating property at a faster rate and over a shorter recovery time by implementing a cost segregation study.

As always, I am available to discuss any of these matters with you.

Your resource for all of your tax, financial, and business planning matters,

Lawrence L. Richards, C.P.A.
December 2006

SPECIAL TAX BULLETIN FOR 2006

The new Pension Protection Act of 2006 (H.R. 4) not only impacts persons who are participants in traditional defined benefit pension plans or multi-employer plans—or who are sponsors of traditional plans or multi-employer plans—it also impacts everyone who is saving for retirement. Highlights of the Act of 2006 are discussed below.

OVERVIEW

The comprehensive pension reform package will cost $73 billion over the next 10 years and makes the most sweeping changes to the pension system in 30 years. It contains provisions that strengthen traditional pension plans, extend over 20 retirement tax-savings benefits, add new rules governing specific charitable donations, impose tighter controls on exempt organizations, and also covers over a dozen other major tax provisions.

The new law also contains a number of provisions that impact charities and charitable donations, technical corrections, and a handful of miscellaneous provisions, including new recordkeeping requirements for cash donations; Federal oversight of charitable organizations; stricter rules for donations of used clothing and household goods; new treatment of donations of fractional interests; special contribution rules for buildings in registered historical districts; and an extension of the rules allowing for Sec. 529 qualified tuition programs.

CHARITABLE DONATIONS

New Rules for Charitable Donations
Americans donate billions of dollars to charitable organizations every year. Many contributions are in cash; others in tangible goods, such as household items and clothing. Because of the huge amounts of money involved, charitable donations have always been ripe for abuse. Congress has known this for a long time, and the new pension reform law cracks down on abusers.

Effective as of the date of enactment of the new law, no deduction will be allowed for any contribution of cash, check or other monetary gift unless you can show a bank record or a written communication from the charity. This means you’ll have to either get a receipt for every cash donation you make or make your donation by check, credit or debit card, so you bank statement will show it. Congress made this change to crack down on taxpayers who inflate their cash contributions.

The new pension reform law also cracks down on donations of broken or malfunctioning household items and poor or soiled clothing. Household items and clothing must be in “good condition” to be deductible. Otherwise, they’re not. There is a limited “antiques” exception for donated single items appraised at more than $500. The IRS is expected to issue guidance about what is “good condition” in time for the 2007 tax filing season, as this change is also effective as of the date of enactment of the new law.

While the new law imposes restrictions on contributions of cash, household goods and clothing, it expands some other deductions. Last year, in response to Hurricane Katrina, Congress enhanced the deduction for donations of food and books. The new law extends this special treatment through December 31, 2007. If you are age 70 ½ or older, you will be able to make a tax free distribution of IRA proceeds up to $100,000 to a charitable organization through December 31, 2007. The new law also increases the deduction limits for qualified conservation easements for 2006 and 2007.

PENSION REFORMS

Background
After years of debate, compromise and often intensely partisan negotiations, Congress has passed a comprehensive pension reform bill. If you are a participant in a traditional single-employer pension plan or a multi-employer plan, you will likely soon be hearing from your plan sponsor.

Traditional Pension Plans in Trouble
Traditional pension plans, which pay a defined benefit over a period of time, are in trouble. Many are underfunded. Others have been turned over to the Pension Benefit Guaranty Corporation (PBGC), the pension payor of last resort. Why have so many failed? The evolution of our economy from an industrial/manufacturing base to a service-oriented one has contributed. Global competition is also a factor. More and more companies have either terminated their traditional pension plans or converted them to 401(k)s or other types of savings arrangements.

Currently, about 30,000 traditional pension plans are underfunded. Some are teetering on collapse. This crisis spurred Congress to enact a comprehensive pension reform bill. The new law aims to prevent any more troubled plans from folding and dumping their obligations on the PBGC, which already has a deficit of nearly $30 billion. Most underfunded plans are required to become fully funded over seven years.

Permanent Retirement Savings Incentives
If you’ve been making higher contributions to IRAs, 401(k)s and similar arrangements, catch-up contributions, and enjoyed greater portability, you’ve benefited from enhanced retirement savings incentives enacted in 2001. Five years ago, Congress passed the Economic Growth and Tax Relief Reconciliation of 2001 (EGTRRA). This law created many new incentives to encourage people to save more for retirement. However, because of its huge price tag, Congress made EGTRRA temporary. All of its tax breaks, including the retirement savings incentives, had been set to expire in 2011. The new pension reform bill makes them permanent. Instead of expiring on December 31, 2010, as scheduled, they are now extended permanently.

Here are some of the highlights.

Higher IRA contribution dollar amounts. EGTRRA gradually raised the amount you can contribute annually to an IRA. For 2006, it is $4,000. That amount rises to $5,000 in 2008. The new law makes the $5,000 amount permanent and adjusts it for inflation after 2008.

Higher dollar limits on defined contribution plans. If you have a 401(k), 457 or similar plan, the new law makes permanent EGTRRA’s higher dollar limits on defined contribution plans ($44,000 in 2006), as well as elective deferrals for 401(k)s, 457s and SIMPLE plans. The new law also makes permanent EGTRRA’s more generous treatment of compensation that may be taken into account under a plan.

Catch-up Contributions. If you are age 50 or older, you should be making catch-up contributions. EGTRRA allowed individuals age 50 and older to make additional contributions to IRAs, 401(k)s and other arrangements. For 2006, you make an additional catch-up contribution of $1,000 to an IRA if you are age 50 or older. You can make an additional catch-up contribution of $5,000 to a 401 (k) plan if you are age 50 or older. Because EGTRRA is temporary, you would not have been able to make catch-up contributions after 2010. The new pension reform law makes catch-up contributions permanent. It also indexes the $5,000 401 (k) catch-up amount for inflation but not the $1,000 IRA catch-up amount.

Roth 401(k)s. You’ve probably heard a lot about Roth 401(k)s over the past few months. While they were created as part of EGTRRA in 2001, employers could only start offering them this year. Roth 401(k)s are similar to Roth IRAs. Depending on your income and where you are at in your work life, if you’re just starting out or nearing retirement, Roth 401(k)s can be a valuable addition to your retirement portfolio. Until this new law, many employers were reluctant to offer Roth 401(k)s because they would have expired after 2010. The new law makes them permanent, and this could encourage more employers to offer them.

New and Enhanced Incentives
Besides making the retirement savings breaks in EGTRRA permanent, the pension reform law also creates some new incentives. You can ask the IRS to deposit your tax refund into an IRA (effective for 2007). The new law also allows direct rollovers from a qualified retirement plan, tax sheltered annuity or government plan directly to a Roth IRA and will treat it as a Roth conversion if all other qualifications are met (effective for 2008). In another important development, non-spousal beneficiaries can roll over their interests in a qualified retirement plan, government plan or tax-sheltered annuity into an IRA (effective for 2007). Previously, this treatment was only available to spouses. The new law also allows IRA and 401(k) providers to offer personalized investment advice (starting in 2007).

More Incentives
In addition to these valuable savings incentives, the new pension reform law also makes permanent: greater portability for 403(b) and 457 plans; faster vesting of employer matching contributions; and the saver’s credit. For small businesses thinking of starting a pension plan, the new law makes permanent the tax credit for start-up costs.

Avoiding a Bailout
Before closing, let’s take another look at the pension reform parts of the new law. As we said earlier, approximately 30,000 plans are underfunded to the tune of $450 billion. Congress wants these plans to survive, so it is giving plans seven years (longer for the airline industry) to become fully funded. “At-risk” plans, which are critically underfunded, get some additional help, but they also have more responsibilities to their participants. The new law also changes the rules for valuing pension liabilities. Most of the pension reform provisions take effect after 2007, with some exceptions.

START PLANNING

The new pension reform law is 900 plus pages. It impacts everyone and not only individuals with traditional pension plans. The retirement savings incentives in the new law are invaluable and can significantly maximize your retirement portfolio and give you generous tax breaks. The new charitable contribution rules are a mixed bag. Some are generous; other less so.

To take full advantage of the new law, you have to act soon. While many of the new incentives are permanent, others are temporary. Some take effect this year but others not until 2007 or beyond. Give our office a call today. We’ll carefully review your situation and tailor a plan to get you the most out of this valuable new law.

As always, I am available to discuss any of these matters with you.

Your resource for all of your tax, financial, and business planning matters,

Lawrence L. Richards, C.P.A.
December 2006

Postscript
From Los Angeles Times, September 4, 2006, page 1 article “Law May Hasten Decline of Pensions”.

DuPont last week became the third major corporation (after Tenneco, Inc. and Blount International) to announce its reduction of retirement benefits since Congress passed the Pension Protection Act of 2006 on August 3rd. All three companies said they would improve their employees’ 401(k) savings plans. Separately, bankruptcies such as UAL Corp, parent of United Airlines have put pressure on the Pension Benefit Guaranty Corp.

The pension system is in hasty retreat, and little in the new law is likely to stop the trend. This may be the tip of the iceberg; a lot of companies will probably freeze their plans in 2007.

Impending regulatory changes will only accelerate the demise of old-style pensions that guarantee steady income as long as retirees live. Tougher pension accounting rules are scheduled to take effect by the end of this year. The Financial Accounting Standards Board will require companies to include pension funding obligations in their balance sheets, potentially reducing some firms’ net worth. Many see traditional pensions as costly weights on a company’s competitiveness in a very tough competitive environment.

Practical Tip
You should no longer rely only on an employer or the social security system to provide your retirement. Every working person will have to learn how to save a portion of their earnings for their own retirement. We are available to provide general guidance in this area.
 

YOUR LIFE INSURANCE POLICY MAY BE A GOLD MINE!

People often take out a life insurance policy, yet as their lives change, the need for the policy disappears. Not wanting to continue paying, they’ll either turn it back to the original insurance company for cash or just let it lapse. Good news: there’s now an option which can deliver a huge cash payment for this unwanted policy.

Over the last few years, a new market has developed which buys unwanted life insurance policies (called “Life Settlement” market.) They consider a life insurance policy an asset (like real estate) with a market value. They will appraise your policy and often deliver a cash payment much greater than just turning back the policy to the original life insurance company.

For example, a couple in their early 80’s had a $5.0 million life insurance policy they didn’t want anymore. They were about to give the policy back to the insurance company for the $100,000 cash value. Their attorney suggested they try to sell the policy for a higher value in the “Life Settlement Market.” A life insurance broker who specializes in this area was able to deliver a check to them for $800,000.

If you’re over age 70 and you have a life insurance policy which is no longer needed, check with me for a referral to a broker who specializes in this area.

As always, I am available to discuss any of these matters with you.

Your resource for all of your tax, financial, and business planning matters,

Lawrence L. Richards, C.P.A.
December 2005

TAX HIGHLIGHTS FOR 2005

Last year we reported that in late 2004 Congress passed two pieces of legislation: The Working Families Relief Act of 2004 and The American Jobs Creation Act of 2004. On September 23, 2005 the Hurricane Katrina Tax Relief Act of 2005 was signed into law. Some of the changes that affect individuals and businesses in 2005 are included in these Highlights. In addition, certain provisions of The 2005 Bankruptcy Act and The Energy Tax Incentives Act of 2005 will be discussed.

OVERVIEW

In my opinion, the five pieces of legislation did not bring major tax changes. My comments will touch on those changes I believe will impact your 2005 taxes and some changes in store for 2006. If you read or hear about a tax matter that may affect your tax situation and want my reading on it, give me a call.

A year ago I stated that President Bush may be forced to increase income tax rates by the end of 2005 or by 2006 due to the cost of keeping the ‘peace’ in Iraq, a fight over the Social Security Gorilla, and the increasing trade deficit with China. In addition, you can add the cost of Katrina and fighting world terrorism. I still don’t count out a tax increase in 2006.

That brings us to ‘what can each of us do’ to protect our financial security in view of these huge uncontrollable economic tsunamis.

My reply has always been to stick to the basics. Careful financial planning throughout the year is necessary to keep taxes low and to maximize the cash in your pocket for the short and long term.

INDIVIDUAL TAXES

Alternative Minimum Tax (also quite correctly known as the Alternative Mandatory Tax). The AMT tax was designed to ensure that wealthy taxpayers were not able to escape taxation by exploiting deductions. As the AMT tax is not indexed for inflation, more and more people in lower tax brackets are being ensnared into this subterfuge for a tax rate increase.

According to the Congressional Research Service (CRS), the cost of entirely repealing the AMT would be between $640 billion to $1 trillion, if the tax breaks passed during President Bush’s first term are extended beyond 2010 to the year 2013. In addition, some projections suggest that by 2008, it would be less costly to repeal the regular income tax than to repeal the AMT, according to the January, 2004 CRS report. You figure out if the AMT is going to remain law!

To make sure you don’t wind up paying AMT if you can avoid it, start by projecting your income for the rest of this year and next, at the least. That will help your tax advisor to figure out if you should be shifting income and deductions into 2005, since the AMT disallows many deductions that are otherwise are permitted.

Tax tip: Some of the items to consider regarding AMT are: State and local taxes; home equity loans and other mortgage interest not incurred in buying, building, or improving your residence; incentive stock options (these may generate AMT even when sold at a loss); other itemized deductions.

Health Savings Accounts (HSA) Conceptually, an HSA is an individual retirement account for medical expenses. There are two component parts to an HSA: 1) a high-deductible health insurance plan (HDHP) and a 2) health savings account (HSA). Eligible individuals or their employers buy a high-deductible health insurance plan and then makes deductible contributions to a side account, an HSA.

It appears the new HSAs will work best for the healthy, younger person or family, who currently does not incur large medical expenses. An HSA is established for the benefit of an individual, is owned by the individual, and is portable. For individuals, the HSA is an above-the-line deduction rather than an itemized deduction.

A person is not eligible to establish an HSA if they are enrolled in Medicare, or if they may be claimed as a dependent on another person’s tax return. Distributions from HSAs are made on a tax-free basis.

Tax tip: The rules are complex, so seek the guidance of a professional advisor. Additional information is available at www.msabank.com or www.hsainsider.com

Charitable Contributions: Cash contributions to any U.S. charity between August 28 and December 31, 2005 will be fully deductible and not subject to the usual 50 percent contribution base limitation, and will be exempt from the 3% of excess AGI limitation. (This is a side benefit of the Katrina Emergency Tax Relief Act of 2005)
Tax tip: Let your tax preparer know the amount of cash contributions made between August 28 and December 31, 2005, to take advantage of this benefit.

Auto Contributions to Charity – As of January 1, 2005, the rules changed. For 2005, if the claimed value of a motor vehicle, boat, or plane donated to charity exceeds $500, and the item is sold by the charity, the taxpayer’s deduction is limited to the gross proceeds from the sale.

Social Security Benefit Calculator. The Social Security Administration has launched a new Internet service which offers three increasingly detailed levels of benefit estimates. The simplest, “quick calculator”, asks only for your age and current-year earnings. The most sophisticated requires the user to download software into a home computer and allows him or her to try out various retirement scenarios.

Tax tip: Social Security’s new retirement benefit calculator is at www.ssa.gov/retire

Energy Credits. Individuals may claim a deduction of up to $2,000 for hybrid autos acquired in 2004 and 2005. The 2005 Energy Act replaced the deduction with a credit, discussed below.

Tax tip: The Energy Tax Incentives Act of 2005 creates several new tax credits that apply to property placed in service after December 31, 2005. Thus you should consider to defer making some purchases until next year when you have substantial planning time. Be sure to consult experts in this area, as the information below is summarized and does not contain all provisions of the law.

1. Beginning 1-1-06, purchasers and lessors of hybrids, lean-burn vehicles, fuel cell vehicles, and alternative fuel vehicles are entitles to a two-part credit consisting of 1) a fuel economy credit ranging from $400 to $2,400, and 2) conservation credit ranging from $250 to $1,000. You must be the original owner of the vehicle. The credit is available for personal use as well as business use vehicles. Basis must be reduced by the credit.
2. Credit for energy-efficient ‘qualifying’ improvements (insulation, windows, skylights, exterior doors and more) to a primary personal residence by a homeowner made in 2006 and 2007 qualify for a lifetime credit of up to $500.
3. Solar water heaters, photovoltaic or fuel cell equipment placed in service in the taxpayer’s residence in 2006 and 2007 qualify for a 30% nonrefundable credit.
   An annual credit limit of $2,000 per category is set for solar hot water and photovoltaic expenditures, and $500 for each half kilowatt of capacity of qualified fuel cell property.
4. A credit of $2,000 is available to the builder of a home that is substantially completed after 2005 and purchased in 2006 and 2007 if the home achieves a 50% improvement in energy efficiency versus a comparable dwelling constructed under the existing International Energy Conservation Code standards. The credit applies to new construction as well as ‘substantial reconstruction and rehabilitation’.
5. A new deduction (not a credit) is available for the cost of energy-efficient property expenditures for commercial buildings, for property placed in service in 2006 and 2007. Qualified expenditures include 1) interior lighting, 2) heating, cooling, ventilation, and hot water, and 3) the ‘building envelope’.

Capital Gains. The end of the year is the perfect time to examine investments to minimize capital gain income. Taking losses on consistently underperforming investments can offset gains taken on winners, because it may be advisable to sell them to rebalance portfolios. Remember that losses taken in excess of gains offset ordinary income up to $3,000 ($1,500 for taxpayers filing separately).

Many of you have such large capital loss carry overs that you will need to live 100 more years to use up the tax benefit. Capital gains that are absorbed by capital losses and net to zero additional taxable income, can mean ‘free’ money from the sale. Note that we are talking about capital losses from your taxable account, NOT your pension account. Also, that capital losses offset only capital gains, not any ordinary income.

Tax tip: To generate capital gains:

1. Sell the depreciated (and hopefully appreciated) rental.
2. Take taxable boot in an exchange.
3. Sell negative basis limited partnership interest to generate phantom income. There are many old tax shelter partnerships with large negative capital accounts. Maybe it’s time to abandon the interest to the general partner (or sell the interest to a non-relative) and recognize phantom income. Make sure it will be capital gain and not ordinary income before you do the transaction.
4. Sell the appreciated vacation home.
5. Sell the highly appreciated personal residence if gains are in excess of the ‘sale of home exclusion’ ($250,000/$500,000) and generate a capital gain that can be absorbed by the capital loss carry overs.
6. Some appreciated stock is better off not sold, but donated to charitable organizations where they can be deducted at their fair market value.
7. Capital gains can also be shifted to family members in lower tax brackets through gifts of securities. The basis remains the same for donor and donee.
8. Pursuant to a recent development you can elect to treat capital gains and qualified dividends as investment income, taxed at ordinary income tax rates, if you have deductible investment interest expense that will offset it.

Expiring Provisions. One of several items set to expire December 31, 2005 is the higher education expense deduction. This provision permits a maximum deduction of $4,000 in qualified tuition and related expenses for taxpayers whose AGI does not exceed $65,000 ($130,000 for married filing jointly), and $2,000 for filers with AGIs between $65,000 and $80,000 ($160,000 for joint filers).

Tax tip: This deduction is attractive to taxpayers who do not qualify for either the Hope or Lifetime Learning credits, so qualifiers may wish to pay in December, 2005 for coursework that begins during the first three months of 2006.

Retirement Planning. While contributions to IRAs may be applied retroactively if made before the filing deadline, contributions to qualified plans (including ‘catch-up contributions”) must be made before the end of the calendar year.

Some taxpayers may have reached the age at which they must take ‘required minimum distributions’ from a qualified plan and should make sure they have done so during the tax year. Those who became age 70-1/2 during 2005 must take their first distribution on or before April 1, 2006; but you can elect to take that first distribution in 2005 so you don’t have two distributions in 2006.

Tax tip: Taxpayers who are not already maximizing contributions to their retirement plans can reduce their AGI by increasing contributions. This has the added effect of increasing the deductibility of medical and other deductions subject to AGI floors.

Maximum contributions to traditional and Roth IRAs are $4,000, with a $500 additional catch-up contribution for people age 50 and over – as long as the taxpayer and his spouse, even if non-working, have earned income that equals or exceed the maximum contribution. Example: Larry is over age 50 and earns over $8,500 is married to Marcia who is under age 50 and not employed. Their maximum IRA contribution is $8,500.

Tax tip: It is time to consider conversions from traditional IRAs to Roth IRAs, which will generate a potentially large tax bill in 2005, as long as the long-term benefits outweigh the current costs. This is also a good time to consider options for next year. That includes to consider contributions to a Roth 401(k) or 403(b) plan which permits you to make contributions from after-tax dollars, and later to receive tax-free distributions.

The 2005 Bankruptcy Act. This information would be applicable for anyone you know who may be contemplating bankruptcy. It is now tougher to file for bankruptcy.
A Chapter 7 bankruptcy is a liquidation of the debtor’s nonexempt assets that are then used to pay off creditors to the extent possible. The debtor emerges from Chapter 7 bankruptcy discharged of any further obligation to pay creditors, except for taxes, alimony, child support, and student loans.
A Chapter 13 bankruptcy is a plan where the debtor reorganizes his or her financial affairs. The debtor receives a discharge only after completing a court-approved repayment plan.

The first major reform to federal bankruptcy laws since 1978 occurred when the President signed into law The Bankruptcy Act, which took effect October 17, 2005. Generally families earning more than the state median, about $49,000 in California, will face huge roadblocks to filing a Chapter 7 bankruptcy on consumer debts and only be allowed to file Chapter 13 which calls for a debt repayment plan. Prior to seeking
the protection of bankruptcy, debtors will be required to pay for debt counseling as a first step.

A brief summary of some of the major tax related changes to the Bankruptcy Act include:

1. Generally, federal tax debts incurred within 3 years of filing for bankruptcy a) are given priority status, and b) are not dischargeable in bankruptcy.
2. The debtor is required to provide to the bankruptcy trustee prior to the first creditor meeting copies or transcripts of tax returns ending in the four-year period that ends on the date the petition for bankruptcy was filed. Therefore, failure to file a return or untimely filing generally makes the tax liability not dischargeable.
3. Tax liability arising from a fraudulent return is not dischargeable.
4. If the debtor fails to provide the latest tax return at least 7 days before the initial date for the first meeting of creditors, the law requires the dismissal of the Chapter 7 or 13 case.
5. Retirement plans
   a. To the extent they are exempt under the Internal Revenue Code, a qualified retirement plan, traditional IRA, Roth IRA, multi-employer plan, government plan, and tax exempt plan are excluded from the bankruptcy estate.
   b. Debtor’s loans from his retirement plan are not dischargeable.
   c. The exclusion limit for an IRA account is $1 million. The limit does not apply to the SEP IRA, the 401(k) Roth, or the SARSEP. It also does not apply to IRA accounts rolled over from qualified accounts.
   Tax tip: Two good reasons to keep your rollover accounts separate from other IRA accounts are 1) you can later rollover the account balance into a new employer’s 401(k) account, and 2) the account balance is protected from creditor claims in bankruptcy.
6. Coverdell Education Savings Accounts (CESA) and Section 529 plans.
   a. An exemption from the bankruptcy laws is allowed for CESA and 529 plans if the debtor contributed to an account where the designated beneficiary is the debtor’s child, stepchild, grandchild, or step-grandchild. Contributions to a CESA must be for a child under 18 years of age.
   b. However, no age limit exists for a donor’s contribution to a 529 plan for the benefit of any other beneficiary.
   c. There are no bankruptcy exclusions, or limited exclusions for funds deposited to the CESA or 529 plan within certain time limits.

BUSINESS TAXES

Production Activity Deduction. The most significant provision for 2005 is the Production Activity Deduction (new code section 199). For 2005 and 2006 the deduction is equal to 3% of the lesser of 1) the qualified production activities income of the taxpayer or 2) taxable income (determined without regard to this provision). For taxable years beginning in 2007, 2008, and 2009, the deduction is increased to 6%, and for taxable years beginning after 2009, the deduction is increased to 9%. The deduction is limited to 50% of the W-2 wages of the taxpayer. The taxpayer is any business entity.

Qualified production activities include the U.S. manufacture, production, growth or extraction of tangible personal property, software development, certain sound recordings, certain qualified film produced by the taxpayer, U.S. production of electricity, natural gas or potable water, construction or substantial renovation of real property in the U.S. including residential and commercial buildings and infrastructure such as roads, power lines, water systems, and communications facilities. and engineering and architectural services preformed in the U.S. and relating to construction of U.S. real property.

Code section 199 contains many provisions and qualifications. If you believe this deduction may apply to your business, you should contact your tax advisor.

Bonus depreciation expired 12-31-04.

Section 179 expensing is $105,000 for property placed in service in 2005 ($108,000 in 2006) The deduction applies to purchases of up to $420,000 for 2005 ($430,000 for 2006). This limitation is scheduled to drop back to $25,000 of purchases in 2007, so consider making your equipment purchases in 2005 and 2006.

As always, I am available to discuss any of these matters with you.

Your resource for all of your tax, financial, and business planning matters,

Lawrence L. Richards, C.P.A.
December 2005

IRS AUDITS S CORPORATIONS

IRS AUDITS S CORPORATIONS

The IRS is launching a new research compliance program of S corporations.  The study will examine 5,000 randomly selected S corporation returns from tax years 2003 to 2004.  The 5,000 represents 1.6 thousandths of 1% of all S corporations.

The last compliance study was in 1984, prior to tax law changes that spurred the growth of S corporations from 724,749 to 3,154,377 in 2002.

Purpose of the audits

Research programs are undertaken periodically to ensure that corporations and individuals pay their fair share of taxes.  Based on study results using statistical analysis, the IRS updates its methods of finding returns that might potentially have problems.

Salary abuse

The impetus for the S corporation study is a result of Social Security hearings early in 2005.  The highlight of the hearings was the loss of payroll revenue to the federal government.  “People are taking salaries that are too low, sometimes as little as zero, to beat the 15.3% FICA tax.  Or there are those who pay themselves $10,000, but take out $90,000 in distributions.”

Inappropriate deductions

The study expects to find a disproportionate amount of inappropriate deductions in small and midsized businesses.

WHAT YOU SHOULD DO BEFORE AN AUDIT

Compensation to owner employees should be reasonable: what you would have to pay a third party to perform your services.  In addition, all expenses should be directly related to the business of the S corporation, and be well documented.  Contact your CPA to determine if you will pass the new IRS research program audit.

As always, I am available to discuss any of these matters with you.

Your resource for all of your tax, financial and business planning matters,

Lawrence L. Richards, C.P.A.

TAX HIGHLIGHTS FOR 2004

On October 4, 2004, Congress passed The Working Families Tax Relief Act of 2004. The Act prevented a tax increase of $146 billion by virtue of extending that amount of tax cuts that were scheduled to expire in 2004.

OVERVIEW

Other than a new sales tax deduction option, the expiration of the 50% bonus depreciation at 12-31-04, and major change in deduction for cars donated to charity after 12-31-04, 2004 was reasonably quiet for tax changes. The only thing that will ‘stick it to you’ is the Alternative Minimum Tax. Income tax changes in recent years continued to reduce regular tax, but haven’t affected the AMT tax much. We can expect that more and more taxpayers will be paying an AMT tax and wonder where their share of all the tax deductions went!

Don’t count out the abolishment of the estate tax in 2005. Right now you get taxed when you earn, again when you save, and again when you get dividends. And if you’re stupid enough to die, they tax you again.

My assessment of the cost of keeping the “peace” in Iraq and Afghanistan, a major political fight over the Social Security gorilla, the increasing humungous trade deficit with China, is that President Bush may be forced to increase income tax rates by the third quarter of 2005 or by 2006. In the near future we must consider that foreign creditors who are letting us borrow $600 billion a year may decide that it’s not a wise portfolio choice on their part. Couple this with the fact that as a nation we are saving less than 2% of our national income (the lowest since 1934), and you might conclude some major fiscal juggling is in order.

INDIVIDUAL TAXES

Individual tax rates have been cut every year in the last 4 years. They will be the same in 2004 and 2005 as they were in 2003. The spread between the lowest and highest rates (excluding the low income 10% bracket) is the narrowest in memory.

Planning pointer: Parents should consider shifting income to their 14 and older children to take advantage of the 10% bracket. You can give appreciated stock to the children which they can sell and pay a 5% capital gains tax if they are in the 10% bracket.  Examples: The child who is a dependent of his parent can take capital gains of about $16,000 and pay no tax, saving the parent in the 28% or 35% bracket from $4,400 to $5,500 in taxes. If the child is not a dependent he can take capital gains of about $30,000 and save the parent between $8,500 to $10,500 in taxes.

Long-term care insurance. There are 77 million baby boomers and they represent a third of the U.S. population. The Congressional Budget Office predicts that long-term care costs will rise from $123 billion to $207 billion by 2020. It is cost effective to purchase long-term care insurance before retirement when it is affordable, and before inflation makes it more difficult. Some pointers for choosing a long-term care policy are:

1. Determine resources. If you qualify for Medicaid, you don’t have enough money for premiums.

2. Purchase at the appropriate age to save on premiums.

3. Don’t forget inflation protection.

4. Buy a tax qualified plan. Nearly 90% of plans sold are tax qualified.

State and local general sales tax deduction (new)
In October of this year, Congress passed another tax Act which included the following: At the election of the taxpayer, an itemized deduction may be taken for State and local general sales taxes in lieu of the itemized deduction for state and local income taxes. Taxpayers have 2 options to determine the sales tax amount: 1) Accumulate receipts that show the general sales tax paid, or 2) Use IRS tables, plus general sales tax paid for the purchase of motor vehicles, boats, aircraft, home, or home building materials. [IRS tables can be found at www.irs.gov/pub/irs-pdf/p600.pdf]  (NOTE: the general sales tax rate in California is 6.0%. Do not include the local sales tax. i.e. Total sales tax in Los Angeles is 8.25% and in Anaheim is 7.75%, but you can only deduct at the general sales tax rate of 6.0 %.)

You would then compare the highest of 1) or 2) with your State and Local income taxes to determine which gives you the best deduction.

NOTE: The sales tax deduction in lieu of state and local income taxes is most favorable to low income taxpayers and taxpayers in zero income tax states like Nevada, who itemize deductions. It is also a hassle to deal with. The IRS table amount for a family of 2 with adjusted gross income of $75,000 would be $836, excluding autos, etc.

Auto contributions to charity – LAST CHANCE FOR 2004 – rules change in 2005
Under rules in effect for 2004, taxpayers can deduct the fair market value of autos donated to charity. They should take the following steps:

• Check that the organization is qualified

• Itemize your deductions in order to receive the benefit

• Calculate the fair market value

• Deduct only the car’s fair market value

• Document the charitable contribution deduction

As of January 1, 2005, the rules change. For 2005, if the claimed value of a motor vehicle, boat, or plane donated to charity exceeds $500 and the item is sold by the charity, the taxpayer’s deduction is limited to the gross proceeds from the sale. The charitable organization must provide an acknowledgement to the donor within 30 days of the sale, stating the amount of gross proceeds. Alternatively, if the charity significantly uses or materially improves the vehicles, the charity must certify this intended use and duration and provide an acknowledgement to the donor within 30 days of the contribution – in which case the donor may deduct the vehicle’s fair market value.

Although charities that accept donated vehicles should know the rules in 2005, they may not decide on a sale until months after the donation. Therefore, prior to the donation in 2005, have an understanding with the charity as to whether they will sell or use the vehicle.

Social security and Medicare. The wage base is projected to increase from $87,900 (2004), to $90,000 (2005), $93,000 (2006), $97,500 (2007) and $101,400 (2008). Medicare B premium was $66.60 a month in 2004, and will be $78.20 a month in 2005.

Health Savings Accounts (HSA). This is a new medical expense plan effective January 1, 2004. Conceptually, the HSA is an individual retirement account for medical expenses. Earnings are generally exempt from tax. Favorable deductions are available to individuals and self-employed persons. The plan works best for healthy, younger persons or families, who currently do not incur large medical expenses. They will be able to fund an HSA for use in later years when their medical bills will probably be greater and at the same time reduce current year outlay for medical insurance costs. The plan may be attractive to small employers who are looking to control the exponential rise in insurance premiums for employees. Distributions from HSA are tax-free, provided the distributions relate to qualified medical expenses of the account beneficiary or family members.  The rules are complex. You may contact me for further information or find information at www.msabank.com or www.hsainsider.com.

FDIC coverage for bank accounts in excess of $100,000. The rules are simplified and expanded. Bank funds in a Family Trust, Decedent’s Trust, or Marital Trust that covers Trustors and various beneficiaries will receive $100,000 coverage for each person (covering a person only once). Old rules protected the owner of the Trust and not the beneficiaries.

Domestic partners. Effective January 1, 2005, those registered with the State as Domestic Partners will be subject to community property laws, will be responsible for their partner’s debts, and be subject to the California court system. More information is available to www.aclu.org/getequal/rela/california.html  and www.ss.ca.gov/dpregistry/ .

BUSINESS TAXES

S corporations. An election can be made to allow members of a family to be treated as one shareholder in determining the number of eligible shareholders, which has been increased to 100. (A family is defined as the common ancestor and all lineal descendants of the common ancestor, as well as the spouses, or former spouses of these individuals – for six generations or less removed from the youngest generation of shareholders who would (but for this rule) be members of the family.)

Substantiation for business use of autos, home computers and cell phones. The general rule for autos has been to take your odometer reading at the start and end of the year to know total miles driven. Then, to determine the business miles by maintaining a log that shows business miles driven, date driven, and business purpose. From this you can determine the percent business use and apply the percent to the actual expenses, or use the business miles times the mileage rate allowance. (For home computers and cell phones the regulations suggest using ‘minutes of use’ instead of miles.)

You may also arrive at business use by a sampling method by maintaining your log or record for 3 months, or one week a month.

Bonus depreciation expires December 31, 2004. The rule has been that you can elect either 30% or 50% of special depreciation on any original use property (including automobiles) used in a trade or business which is depreciable under the MACRS system of depreciation with a recovery period of 20 years or less. If business use of the property falls to 50% or less, bonus depreciation and any amount expensed under Section 179 must be recaptured (taken into income).

There is little time left this year to acquire and put into use before December 31, 2004, property that will be eligible for bonus depreciation.

Section 179 expensing. This section allows a taxpayer to deduct a portion of the cost of certain new or used business personal property instead of depreciating it. The maximum deduction for 2004 is $102,000.

After October 22, 2004, this deduction is limited to $25,000 for a sports utility vehicle rated at 14,000 pounds gross vehicle weight (GVW) or less. An SUV is defined to exclude any vehicle that 1) is designed for more than nine individuals in seating rearward of the driver’s seat, 2) equipped with an open cargo area, or a covered box not readily accessible from the passenger compartment, of at least six feet in interior length, or 3) has
an integral enclosure, fully enclosing the driver compartment and load carrying device, does not have seating rearward of the driver’s seat, and has no body section protruding more than 30 inches ahead of the leading edge of the windshield.

Auto expense. The rules for depreciation of autos are very complex. Autos are grouped into several ‘categories’, each with different rules.

1. Passenger autos included any four-wheeled vehicle manufactured primarily for use on public streets, roads, and highways that has an unloaded GVW (i.e. curb weight fully equipped for service but without passengers or cargo) of 6,000 pounds or less.

2. Trucks or vans (including a sport utility vehicle or minivan built on a truck chassis) are treated as passenger autos if they have a gross vehicle weight rating (i.e. maximum total weight of a loaded vehicle as specified by the manufacturer) of 6,000 pounds or less.

3. Some large SUVs, trucks, and vans (i.e. over 6,000 pounds gross vehicle weight rating) are not treated as passenger autos.

4. SUVs (see page 4 under Section 179 expensing for a special rule)

NOTE: The GVW is listed on a metal plate on the inside of the driver’s door. GVW can be found at www.kiplinger.com/php/tools/trucktax/tax.php  or www.intellichoice.com.

Depreciation rules for the above categories of autos.

1. Passenger autos are called ‘listed property’ (which by nature lends itself to personal use), and are also ‘luxury’ autos if their cost exceeds $14,800. IRS tables for passenger autos allow the least amount of depreciation for this category of auto.

2. Trucks or vans (including a sport utility vehicle or minivan built on a truck chassis) of 6,000 pounds or less are entitled to slightly higher depreciation based on IRS tables, to account for higher costs associated with these vehicles.

3. Large SUVs, trucks, and vans over 6,000 pounds are not subject to the depreciation caps applicable categories a. and b. above. These vehicles are allowed Section 179 expensing on the first $102,000 of cost, then 30/50% bonus depreciation if acquired and put into use prior to January 1, 2005 (on the remainder of cost), and regular MACRS depreciation (on the balance of cost). (As to SUVs, see page 4 under Section 179 expensing for a special rule)

IRA provisions. The baby boomers, born between 1946 and 1964, represent almost 1/3 of the United States population. Of our 281 million people, 76.9 million were 50 and older. In the next 10 to 15 years about ½ of the baby boomers (40 million) are going to question, worry, and plan for retirement. 46.3 million taxpayers held IRA accounts worth a total of $2.6 trillion in fair market value. There are 3 rules for comfortable retirement:

• start saving early

• save more money

• invest wisely

The maximum contribution to a Traditional or Roth IRA is $3,000 ($4,000 for 2005 to 2007). Those age 50 and over are allowed an additional ‘catch-up’ contribution of $500 (2004 to 2005) – subject to earned income, if neither spouse is in an employer plan.

ADDITIONAL TAX HIGHLIGHTS

Additional Tax Highlights can be found at our web site at www.llrcpa.com  under Breaking News, as Tax Highlights for 2003. The topics listed there that have not changed in 2004 offer additional valuable insight to the tax laws affecting you – explained in easy-to-understand language, with many planning pointers. The 2003 topics that remain unchanged in 2004 are:

• Individual and corporate rates

• 10% tax bracket expanded

• Dividend income now taxed at 5% and 15% rates

• Social Security benefit calculator

• Alternative Minimum Tax

• Self-employed health insurance

• Long-term care insurance

• Section 529 educational plans

• Gift tax

• IRA provisions

• Sale of stock by nonresidents

• Reduction in capital gains rate

As always, I am available to discuss any of these matters with you.

Your resource for all of your tax, financial and business planning matters,

Lawrence L. Richards, C.P.A.

TAX HIGHLIGHTS FOR 2003

In mid-year, I sent all of my clients and friends a Special Bulletin outlining the Jobs and Growth Tax Act of 2003. If you’d like another copy, please contact me. In this bulletin I will only highlight certain provisions of the Act, outline several tax planning pointers.

As far as complexity and volume of material, just consider this . . .

Book	Number of Words
War and Peace	660,000
The Bible	774,746
The Internal Revenue Code	over 2.8 million

Individual Taxes

Individual and corporate rates are pretty much the same.

Individual rates, 2003 to 2010 Corporate rates, with taxable at:	10%  15%  25%  28%  33%  35%
Less than $50,000	15%
$50,001 to $75,000	25%
$75,001 to $100,000	34%
$100,001 to $$335,000	39%
$335,001 to $10,000,000	34%

10% tax bracket expanded to $7,000 (single), and $14,000 (married), adjusted for inflation in 2004. (Reverting in 2005 to 2007 to $6,000 (single) and $12,000 (married). Planning pointer: Here is an opportunity for parents to shift income to their age 14 and older children to take advantage of this bracket.

Dividend income now taxed at 5% and 15% rates. Taxpayers in the 15% and 10% regular tax brackets are taxed at 5% for dividends. Taxpayers in regular tax brackets over 15%, will have dividends taxes at a 15% rate. Pointer: If you do not hold a share of stock for more than 60 days during the 120-day period beginning 60 days before the ex-dividend  date, dividends received on the stock are not eligible for the reduced rates. Note: California provides no special tax treatment for dividends, which are taxed as the taxpayer’s regular rate.

Social Security benefit calculator at www.ssa.gov/retire offers three increasingly detailed levels of benefit estimates for your retirement benefits. You can 1) calculate your retirement benefits using different retirement scenarios, b) find out how certain types of earnings and pensions can affect your retirement benefits, c) see if your spouse and children will be eligible for Social Security benefits on your records, and more.

Alternative Minimum Tax (or is it the Mandatory Minimum Tax?) This is no joke!

According to a Congressional Research Service (CRS) report, “The Alternative Minimum Tax for Individuals”, the number of taxpayers subject to the AMT will increase from approximately 1.8 million in 2001 to over 35 million (33 percent of all taxpayers) by 2010, if no tax legislative changes are made. It is estimated that repealing the individual AMT would cost from $640 to $840 billion over the 2003-2012 period. So, let’s figure that AMT is here to stay.

Three items presently account for 90% of the dollar value of AMT additions to regular tax.. The top six preferences are:

1)  State and local tax deductions, 2) Personal exemptions, 3) Miscellaneous deductions above the 2% floor, 4) Net operating losses, 5) Incentive stock options, and 6) Passive items

Some AMT Planning Pointers: (You should seek a professional to assist you with these calculations) ): 1) See if spreading the preference items between two years reduces or increases the AMT tax rate, 2) Prepay state income and property taxes cautiously. The deduction may be wasted in an AMT year. 3) Interest paid on home equity borrowing for ‘other’ than home improvements is not deductible for AMT, 4) If an employer will reimburse business expenses, the employee avoids AMT on this preference.

There are more.

Child tax credit refund of $1,000 was mailed to taxpayers during July and August based on information on your 2002 return filed in 2003.  If you were not eligible for the advance payment you may still qualify for the increased child tax credit of up to $1,000 when you file your 2003 tax return. Please let your tax preparer know the amount of this credit you received in 2003.

Self-employed health insurance, which is an above-the-line deduction, increases to 100% in 2003.  Planning pointer: Medicare premiums and long-term care insurance premiums are considered health insurance for this purpose.

Long-term care insurance. Some pointers for choosing a long-term care policy are:

1. Determine resources.  If you qualify for Medicaid, you don’t have enough money for premiums.

2.  Purchase at the appropriate age to save on premiums.

3.  Don’t forget inflation protection.

4.  Buy a tax qualified plan.  Nearly 90% of plans sold are tax qualified.

Section 529 educational plans.  This is a tax-free method to pay for qualified higher education expenses.  See www.savingforcollege.com  for general information and comparative analysis of the various state plans. See www.scholarshare.com for information for the California ScholarShare plan.

Pros and cons of Section 529 at a glance.

Gift tax.  The 2003 annual exclusion remains at $11,000.

IRA provisions.  An individual can make a contribution to a Traditional or Roth IRA up to the lesser of $3,000 or the individual’s compensation if neither the individual nor the individual’s spouse is an active participant in an employer-sponsored retirement plan.

Individual not active participant, but spouse is.  The IRA deduction is phased out for taxpayers with AGI between $150,000 and $160,000.

Annual IRA contribution limits are increased as follows:

Additional catch-up IRA contributions are permitted for those 50 and over, in the following amounts: