It’s Tax Time! Are You Ready?

If you’re like most taxpayers, you find yourself with an ominous stack of “homework” around TAX TIME! Unfortunately, the job of pulling together the records for your tax appointment is never easy, but the effort usually pays off when it comes to the extra tax money you save! When you arrive at your appointment fully prepared, you’ll have more time to:

• Consider every possible legal deduction;
• Better evaluate your options for reporting income and deductions to choose those best suited to your situation;
• Explore current law changes that affect your tax status;
• Talk about possible law changes and discuss tax planning alternatives that could reduce your future tax liability.

Choosing Your Best Alternatives

The tax law allows a variety of methods for handling income and deductions on your return. Choices made at the time you prepare your return often affect not only the current year, but later year returns as well. When you’re fully prepared for your appointment, you will have more time to explore all avenues available for lowering your taxes.

For example, the law allows choices in transactions such as:

Sales of property

If you’re receiving payments on a sales contract over a period of years, you are sometimes able to choose between reporting the whole gain in the year you sell or over a period of time, as you receive payments from the buyer.

Depreciation

You’re able to deduct the cost of your investment in certain business property using different methods. You can either depreciate the cost over a number of years, or in certain cases, you can deduct them all in one year.

Higher Education Expenses

If you are paying college expenses for yourself, your spouse, or your dependent(s), you may qualify for a tax benefit of either an above-the-line tax deduction or a tax credit.

Where to Begin?

Ideally, preparation for your tax appointment should begin in January of the tax year with which you’re working. Right after the New Year, set up a safe storage location—a file drawer, a cupboard, a safe, etc. As you receive pertinent records, file them right away, before they’re forgotten or lost. By making the practice a habit, you’ll find your job a lot easier when your actual appointment date rolls around.

Other general suggestions to consider for your appointment preparation include…

• Segregate your records according to income and expense categories. For instance, file medical expense receipts in an envelope or folder, interest payments in another, charitable donations in a third, etc. If you receive an organizer or questionnaire to complete before your appointment, make certain you fill out every section that applies to you. (Important: Read all explanations and follow instructions carefully to be sure you don’t miss important data. Organizers are designed to remind you of transactions you may miss otherwise.)

• Keep your annual income statements (e.g., W-2s from employers, 1099s from banks, stockbrokers, etc., and K-1s from partnerships, etc.) separate from your other documents. Be sure to take these documents to your appointment, including the instructions for K-1s!

• Write down questions you may have so you don’t forget to ask them at the appointment. Review last year’s return. Compare your income on that return to the income for the current year. For instance, a dividend from ABC stock on your prior-year return may remind you that you sold ABC this year and need to report the sale.

• Make certain that you have social security numbers for all your dependents. The IRS checks these carefully and can deny deductions for returns filed without them.

• Compare deductions from last year with your records for this year. Did you forget anything?

• Collect any other documents and financial papers that you’re puzzled about. Prepare to bring these to your appointment so you can ask about them.

Accuracy Even for Basic Details

To ensure the greatest accuracy possible in all details on your return, make sure you review personal data. Check name(s), address, social security number(s), and occupation(s) on last year’s return. Note any changes for this year. Although your telephone number isn’t required on your return, current home and work numbers are always helpful should questions occur during return preparation.

Marital Status Change

If your marital status changed during the year, if you lived apart from your spouse, or if your spouse died during the year, list dates and details. Bring copies of prenuptial, legal separation, divorce, or property settlement agreements, if any, to your appointment.

Dependents

If you have qualifying dependents, you will need to provide the following for each:

• First and last name
• Social security number
• Birth date
• Number of months living in your home
• Their income amount (both taxable and nontaxable)

If you have dependent children over age 18, note how long they were full-time students during the year. To qualify as your dependent, an individual who is not a qualifying child must pass several strict dependency tests. If you think a person qualifies as your dependent (but you aren’t sure), tally the amounts you provided toward his/her support vs. the amounts he/she provided. This will simplify making a final decision about whether you really qualify for the dependency deduction.

Some Transactions Deserve Special Treatment

Certain transactions require special treatment on your tax return. It’s a good idea to invest a little extra preparation effort when you have had the following transactions:

Sales of Stock or Other Property: All sales of stocks, bonds, securities, real estate, and any other type of property need to be reported on your return, even if you had no profit or loss. List each sale and have the purchase and sale documents available for each transaction. New for 2011, when a broker knows the purchase price of the stock that was sold during the year, the brokerage firm is required to show that amount on the broker transaction report, Form 1099-B.

Purchase date, sale date, cost, and selling price must all be noted on your return. Make sure this information is contained on the documents you bring to your appointment.

Gifted or Inherited Property: If you sell property that was given to you, you need to determine when and for how much the original owner purchased it and its value when you received it. If you sell property you inherited, you need to know the date of the decedent’s death and the property’s value at that time. You may be able to find this information on estate tax returns or in probate documents. If the property was inherited from someone who died in 2010, special complicated rules may apply in determining your inherited basis. Please call for further details.

Reinvested Dividends: You may have sold stock or a mutual fund in which you participated in a dividend reinvestment program. If so, you will need to have records of each stock purchase made with the reinvested dividends. If you sold mutual fund shares, you may have received a statement from the fund that shows your average cost basis for the shares sold and any “wash sale” adjustments. Be sure to bring this statement to your appointment along with the purchase and reinvestment records you have.

Sale of Home: The tax law provides special breaks for home sale gains, and you may be able to exclude all (or a part) of a gain on a home if you meet certain ownership, occupancy, and holding period requirements. If you file a joint return with your spouse and your gain from the sale of the home exceeds $500,000 ($250,000 for other individuals), record the amounts you spent on improvements to the property. Remember too, possible exclusion of gain applies only to a primary residence, and the amount of improvements made to other homes is required regardless of the gain amount. Be sure to bring a copy of the sale documents (usually the closing escrow statement) with you to the appointment.



Home Energy-Related Expenditures: If you made home modifications to conserve energy (such as special windows, roofing, doors, etc.) or installed solar, geothermal, or wind power generating systems, please bring the details of those purchases and the manufacturer’s credit qualification certification to your appointment. You may qualify for a substantial energy-related tax credit.

Car Expenses: Where you have used one or more automobiles for business, list the expenses of each separately. To claim auto-related business expenses, the government requires that you provide your total mileage, business miles, and commuting miles for each car on your return, so be prepared to have that information available. If you were reimbursed for mileage through an employer, know the reimbursement amount and whether the reimbursement is included in your W-2.

Charitable Donations: Cash contributions (regardless of amount) must be substantiated with a bank record or written communication from the charity showing the name of the charitable organization, date, and amount of the contribution. Cash donations put into a “Christmas kettle,” church collection plate, etc., are not deductible unless verified by receipt from the charitable organization.

For clothing and household contributions, the items donated must generally be in good or better condition, and items such as undergarments and socks are not deductible. A record of each item contributed must be kept, indicating the name and address of the charity, date and location of the contribution, and a reasonable description of the property. Contributions valued less than $250 and dropped off at an unattended location do not require a receipt. For contributions of $500 or more, the record must also include when and how the property was acquired and your cost basis in the property. For contributions valued at $5,000 or more and other types of contributions, please call this office for additional requirements.

Foreclosure or Cancellation of Debt: If you lost your home to a foreclosure, short sale, or voluntary reconveyance, you will have to report both the sale of the home and cancellation of debt (COD) income. However, you may be able to exclude the gain and the COD income under provisions of the tax code. The lender may issue either a Form 1099-A or 1099-C or both. These forms should be retained as they include valuable information needed to report the transaction and exclude debt relief income. It may also be appropriate to contact this office in advance to determine exactly what additional information must be assembled in order to complete your return.

If you had credit card debt discharged, the amount discharged is taxable income and you will receive a 1009-C. If, at the time the debt was forgiven, you were insolvent (where your liabilities were more than your assets), you will be able to exclude the debt relief income to the extent your liabilities exceeded your assets. Please call the office in advance of your appointment to determine what information will be needed.

Tax Breaks for the Self-Employed and Small Business Owners

The following is a compilation of a number of tax breaks available to self-employed individuals and/or small business owners. Some can be implemented before year’s end, providing benefits for your 2011 return, while others will provide planning opportunities for 2012.

• Little or No Profit This Year — The farm and nonfarm optional methods for computing net earnings from self-employment are modified so that electing taxpayers may pay more in optional self-employment taxes and thus become eligible for Social Security benefits.

• The Work Opportunity Tax Credit — The work opportunity tax credit allows employers tax credits (as much as $4,800) for hiring individuals from targeted groups (such as recipients of public assistance and qualified veterans).

• Elect to Deduct Start-Up Costs — Taxpayers can elect to deduct up to $5,000 of start-up and $5,000 of organizational expenses in the first year of a business. Each of the $5,000 amounts is reduced by the amount by which the total start-up expense or organizational expense exceeds $50,000. Expenses not deductible in the first year of the business must be amortized over 15 years.

• Deduct a Home Office — If you work from an office in your home, perform management or administrative tasks from a home office, or store product samples or inventory at home, you may be entitled to deduct an allocable portion of certain costs of maintaining your home. This would include allocated maintenance, utilities, etc.

• Business Travel Break — If you maintain your office in your home and it is your principal place of business, you may be entitled to a special tax break on your commuting costs.

• Establish an Employee Pension Plan — Establishing a pension plan for your employees can help you retain better employees. If you start a pension plan, you can take a credit of up to $500 a year for each of the first three years of the plan. The credit is for 50% of certain start-up costs incurred in each of those years.

• Deduct Vehicle Interest, Tax and License — Normally if you purchase a vehicle, the interest on the loan is treated as nondeductible consumer interest. However, if the vehicle is used partially for business (other than as an employee), then the business portion of the interest can be deducted on your business schedule. The business portions of the personal property tax and license fee can also be deducted on your business schedule. The business portion of the sales tax is added to your vehicle’s basis and depreciated if the actual expense method is used.

• Deduct Health Insurance Off-the-Top — A self-employed individual may deduct the amount paid during the tax year for medical insurance for himself, his spouse, his dependents, and even his children who are under age of 27 even if they are not dependents. There is no limit on the amount that may be deducted, except that the deduction cannot exceed net self-employment income. For this deduction, health insurance includes medical, dental, vision, and long-term care premiums. The medical care insurance isn’t limited by the normal 7.5%-of-AGI floor on itemized medical expenses, and it isn’t a business schedule deduction. Instead, it’s an above-the-line deduction on page 1 of Form 1040.

• Business Education Expense Options — Self-employed taxpayers can treat business education expenses for themselves either as a deduction on the business schedule or as an education tax credit. If the deduction option is chosen, it reduces both self-employment tax liability and income tax liability. How much is saved depends upon your tax bracket.

• Employ Your Child — You can turn some of your high-taxed income into tax-free or low-taxed income by shifting some of your business earnings to a child as wages for services performed by him or her. For your business to deduct the wages as a business expense, the work done by the child must be legitimate and the child's salary must be reasonable.

• Trade-in versus Sale — If you are purchasing a new vehicle or other equipment, you should carefully consider whether to trade in the old asset or sell it in an unrelated transaction. The reason? If the disposition of the old vehicle or equipment would result in a tax loss, you might want to sell it separately. However, if the disposition would result in a tax gain, you would want to trade it in to avoid the gain and instead have it reduce the basis of the replacement asset.

• Avoid Underpayment Penalties — Taxpayers are expected to pay their taxes during the year through the payment of estimated taxes and/or withholding. If you have not paid enough and do not meet one of the exceptions, you could be subject to an underpayment penalty along with an unpleasant tax bill when the tax return is filed. Year-end increased estimates and withholding can mitigate those penalties.

• Borrow to Pay Deductible Expenses before Year’s End — If 2011 was a better than normal year for income, you might consider using a credit card to pay expenses that can generate deductions for this year.

• Contribute to Your Retirement Plan — A variety of retirement plans are available to the small business owner or self-employed taxpayer. Some plans must be set up before year’s end.

Please give this office a call if you have additional questions about any of the tax breaks mentioned above. Most of these benefits require action before 2012 to gain any tax advantage for 2011. However, that does not preclude you from planning in advance for 2012.

2010 New Tax Law Changes

Kevin Huang, CPA was interviewed by KTSF 26 to share the 2010 new tax law changes.

Is it Best to Maximize or Minimize Deductions?

As the end of the year approaches, it’s a good time to review your potential tax deductions and develop a strategy that maximizes the benefits. Most taxpayers may deduct the higher of two amounts from adjusted gross income when figuring their taxable income. These amounts are either a fixed amount set by law (the “standard deduction”) or a listing of the expenses the taxpayer paid during the year that the government allows (known as “itemized deductions”).

The basic federal standard deductions for 2010 are: $11,400 for joint filers, $8,400 for head of household, and $5,700 for others. Add-ons to the standard deduction are allowed for taxpayers (and their spouses, if filing jointly) who are blind and/or age 65 or older. In some years, other add-ons—such as a limited amount of real property tax—are also allowed.

 It would seem to be a simple choice—use the larger of the standard or itemized deductions. However, strategies may be used to maximize the benefits that add complexity. For example:

• Bunching Strategy – If your itemized deductions and your standard deduction are about the same, it may be possible to maximize your itemized deductions every other year and take the standard deduction in alternate years. Methods of doing this are discussed below.
• The Alternative Minimum Tax (AMT) Effect - If you are subject to the AMT, the standard deduction is not allowed at all, but some itemized deductions are. Therefore, if you are subject to the AMT, you should always itemize your deductions.

 Here are some tips on maximizing your itemized deductions:

• Medical – Medical deductions for regular tax purposes are deductible only to the extent that they exceed 7.5% of your Adjusted Gross Income (AGI). That percentage increases to 10% for the AMT. Where possible, consider prepaying or deferring medical expenses to match your deduction strategy. In addition to the normal medical deductions, don’t overlook the costs of fertility procedures, learning disability expenses, nursing home expenses, pregnancy tests, certain special education, prescribed smoking-cessation programs, certain weight-loss program expenses, and certain impairment-related expenses.

A child’s medical expenses paid for by divorced parents are generally deductible by the parent who pays the expense. You can also deduct medical expenses for an adult “medical dependent.” Generally, one who would qualify as your dependent except for gross income limitations.

• Taxes – Deductible taxes include real and personal property taxes as well as state and local income taxes. Generally, real property taxes are paid in two or more installments during the year. This gives you the opportunity to “bunch” tax payments by paying an entire year’s tax bill plus one or more installments from the prior year all in one tax year.

If you are paying state estimated taxes, the fourth quarter’s payment is due by January 18, 2011 in most states. However, you have the option to pay it before the end of the year and move the deduction into 2010. Keep in mind that taxes are not deductible for AMT purposes.

• Charitable Contributions – Charitable contributions are deductible for both the regular tax and the AMT. Because they are discretionary, a taxpayer can choose when to make a payment. For example, you could prepay your 2011 tithes in 2010, thereby doubling up deductions in 2010.

Don’t overlook year-end non-cash contributions of items lying around the house that are never used. As long as they are in good or better condition and are contributed to a charity before the close of the year, the contribution will count as a deduction for 2010 (provided you have proper documentation).

• Miscellaneous Deductions – This is a catch-all category that generally includes investment and employee business expenses. These deductions are only allowed to the extent that they exceed 2% of your AGI—but not at all for AMT purposes. Don’t overlook potential losses from IRA and variable annuity accounts that have declined in value during the recession. However, utilizing these losses requires special action, so please call for details.

Because of the 2% of AGI limitation, certain otherwise-deductible expenses might be handled differently, such as working out a reimbursement plan from your employer for employee business expenses. Doing so may mean reducing your salary, but you will be converting taxable income to non-taxable reimbursement—always a desirable outcome. If your miscellaneous deductions are less than 2% of your AGI, consider paying IRA fees from the IRA account instead of making a separate payment.

If you believe you are a candidate for deduction planning, please call this office for an appointment.

Maximizing Credits to Reduce Taxes

There are a number of credits that can help reduce your tax bite for 2010. Unlike a deduction (which reduces your taxable income and thus provides a benefit equal only to the deduction amount times your tax rate), a tax credit is a dollar-for-dollar reduction of your tax. For some credits―such as the Earned Income Tax Credit, Child Tax Credit, Child and Dependent Care Credit, and others―there’s not much you can do to change the outcome. However, there are some credits, described below, that offer year-end tax planning opportunities.

Maximize Education Credits – If you have a child in college for whom you claim a dependent exemption and you or someone else is paying the tuition for that child, you probably qualify for either the American Opportunity Credit or the Lifetime Learning Credit. The credits begin to phase out for higher-income taxpayers whose modified adjusted gross income is $80,000 or more ($160,000 for married couples filing a joint return).

• American Opportunity Credit - Maximum credit is obtained from $4,000 of tuition and qualified expenses that provides a credit up to $2,500 (100% of the first $2,000 and 25% of the balance). Under normal circumstances, education credits are non-refundable; that is, they offset only a taxpayer’s tax liability. However, for this credit, up to 40% can be refundable.
• Lifetime Learning Credit - Maximum credit is obtained from $10,000 of tuition and qualified expenses that provide a 20% credit up to $2,000.

 If you have not already paid the maximum expenses for the year, it may be appropriate for you to prepay certain expenses that apply to the first quarter of 2011. The laws generally allow you to prepay tuition for an academic period that begins during the first three months of the next tax year, and then you can claim the prepaid amount for the current year’s credit. Please contact this office for additional information on this tax strategy or other issues relating to education tax benefits and credits.

Take Advantage of the Home Energy Property Tax Credit – 2010 is the final year to take advantage of the “Home Energy Property Credit” that provides a tax credit for energy-saving improvements made to a taxpayer’s principal residence. The credit is limited to $1,500 (30% of up to $5,000 of qualified expenditures) for improvements made in 2009 and 2010. So, if you claimed this credit in 2009, the most you can claim for energy property improvements for 2010 is the $1,500 maximum less any amount claimed in 2009.

Qualified improvements (those certified by the manufacturer to qualify for this credit), the use of which must originate with the taxpayer, must have a reasonable expected life of at least five years, and include:

o Energy-efficient Exterior Windows and Skylights,
o Energy-efficient Exterior Doors,
o Energy-efficient Metal Roofs with appropriate pigmented coatings,
o Energy-efficient Asphalt Roofing with appropriate cooling granules,
o Energy-efficient Heating Systems,
o Energy-efficient Air Conditioning Systems and
o Insulation Materials or Systems designed to reduce heat loss or gain.

Credit is not allowed for onsite preparation, assembly, or installation of the component. It is a non-refundable personal credit; thus, the credit can be used only to bring your tax (including the alternative minimum tax) down to zero. Any excess is not refundable and cannot be carried over to a subsequent year.

Pick a Hybrid or Lean-Burn Vehicle – If you are planning to purchase a new automobile before the end of the year, it might be appropriate to purchase either a hybrid or lean-burn vehicle. Credits for these types of vehicles range from $900 to $2,350. However, this credit has phased out for most manufacturers and is currently available only on qualified vehicles manufactured by General Motors, Chrysler, Nissan, Mazda, BMW, and Mercedes for hybrid vehicles, and by Volkswagen, Audi, and Mercedes for qualifying lean-burn vehicles.

This credit is a non-refundable personal credit, which means it can reduce your tax only to zero, and any balance is lost. However, if the vehicle is used partially for business, the portion of the credit attributable to business use becomes a general business credit, and any amount not used in 2010 carries back one year and forward for 20 years until used up.

If you have questions about how any of these credits will impact your specific circumstances or would like to schedule a year-end planning appointment, please call this office.

New Breaks for Small Businesses

The 2010 Small Business Jobs Act enacted September 27, 2010 includes an assortment of incentives and tax breaks for small businesses. The following is a brief overview of some of the key provisions included in the new law. Watch for additional details in future newsletters.

• Cell Phones No Longer Listed Property - This means that cell phones can be deducted or depreciated like other business property, without the complicated recordkeeping required for listed property. This is effective for tax years beginning after Dec 31, 2009.
• Business Owners’ Health Insurance Deduction Reduces Self-Employment Tax - The new law allows business owners to deduct the cost of health insurance incurred in 2010 for themselves and their family members in calculating their 2010 self-employment tax.
• Boosted Deduction for Start-up Expenditures – For 2010, businesses can deduct up to $10,000 (was previously $5,000) in trade or business start-up expenditures. However, the $10,000 limit is reduced by the amount by which start-up expenditures exceed $60,000 (was previously $50,000).
• Increased Small Business Section 179 Expensing –Small business taxpayers can elect to write off the cost of certain capital expenses in the year of acquisition in lieu of recovering these costs over a period of years through depreciation.
  
  For tax years beginning in 2010 and 2011, the new law allows a taxpayer to expense up to $500,000 (up from $250,000 under prior law) of qualifying property which includes machinery, equipment and certain software placed in service during the year. For 2010 and 2011, the annual expensing limit is reduced by the cost of qualifying property that is placed into service during the year exceeding the $2 million (was $800,000) investment limit.
• Certain Real Property Can Be Expensed – The new law also makes certain real property eligible for Sec 179 expensing. For property placed in service in any tax year beginning in 2010 or 2011, the up-to-$500,000 deduction of property expensed can include up to $250,000 of qualified real property (qualified leasehold improvement property, qualified restaurant property, and qualified retail improvement property).
• 50% Bonus First-Year Depreciation Extended - Businesses normally can only deduct the cost of capital expenditures over time through depreciation—most commonly at the rate of about 14% or 20% of the cost of machinery or equipment for the first year. For 2008 and 2009, businesses were permitted to write off 50% of the cost of new machinery and equipment placed in service during those years. In the new law, Congress extends the first-year 50% write-off to qualifying property placed in service in 2010 (2011 for certain property).
• General Business Credits for 2010 Can Be Carried Back 5 Years – Under the new law, for the first tax year beginning in 2010 (2010 for calendar year taxpayers), eligible small businesses (ESB) (generally one with $50 million or less in average annual gross receipts for the prior three years) can carry back unused general business credits for five years. ESBs include sole proprietorships, partnerships and non-publicly traded corporations.
• General Business Credits of Eligible Small Businesses in 2010 Aren't Subject to AMT - Under the Alternative Minimum Tax (AMT) rules, taxpayers can generally only claim allowable general business credits against their regular tax liability, and only to the extent that their regular tax liability exceeds their AMT liability. A few credits, such as the credit for small business employee health insurance expenses, can be used to offset AMT liability. The new law allows eligible small businesses, as defined above, to use all types of general business credits to offset their AMT in tax years beginning in 2010.
• Other Provisions With Limited Application – Calculations of the built-in gains tax on S-Corporations converted to C-Corporations, special rules for long term contract accounting and limitation on the penalty for failure to disclose certain reportable transactions (including listed transactions) on a return.

If you have questions related to any of these new tax benefits or wish to schedule a tax planning appointment to see how your business might benefit, please give this office a call.

E-File is the Trend!

If you file 250 or more Forms W-2, then you must file them electronically. The IRS encourages you to file electronically even if you are filing fewer than 250 Forms W-2. With the continued growth in electronic filing and to help reduce costs, the IRS will no longer mail paper tax packages. The benefits of filing electronically are:

1. It is quicker and more efficient.
2. Social Security Administration's Business Services Online (BSO) can be used to check the status of online submissions.
3. BSO can also be used to check if a submission had any errors.

Electronic filing of Forms W-2 and W-3 is free HERE.