Deduction Tips for Contributors to Haiti Relief Effort

Haiti Contributions Deductible on 2009 Return - Congress has passed a bill (HR 4462) to permit taxpayers contributing to Haitian relief charities to elect to treat contributions made after Jan. 11, 2010, and before Mar. 1, 2010, as if the contributions had been made on Dec. 31, 2009. If the election is made, Haiti relief donations would be deductible on the 2009 return, not the 2010 return. This option would be available only if the contribution is made in cash and otherwise meets the requirements for charitable contribution deductions under Code Sec. 170 as summarized below.  

• Contributions to domestic, tax-exempt, charitable organizations providing assistance to individuals in foreign lands are tax-deductible, provided that the U.S. organization has full control and discretion over the uses of donations.

• Contributions to foreign organizations generally are not deductible, nor are contributions to benefit specific individuals or families.

• To substantiate charitable contributions of money, regardless of amount, a taxpayer must have a bank record or a written communication from the charity showing the name of the charity and the date and amount of the contribution.  One additional substantiation method is allowed individuals for Haitian relief contributions: monetary contributions made via text message on a cellular telephone may be substantiated with a telephone bill that shows the charitable organization’s name, contribution date, and the amount of the contribution.

• Contributions are deductible in the year made unless donated for Haitian relief after Jan. 11, 2010, and before Mar. 1, 2010, in which case the contribution can be taken in on either the 2009 or 2010 return.  To claim the donations, the taxpayer must itemize deductions.

• Generally, the deduction for charitable contributions is limited to 50% of the taxpayer’s adjusted gross income, with a 5-year carryover period for excess deductions. The Haitian relief donations are subject to the normal limitations and carryover.

For high-income taxpayers, there is also a limitation on overall itemized deductions for 2009, but there is no overall limitation for 2010.  Therefore, the tax benefit for these individuals may be greater by waiting until 2011 to claim their Haitian relief donations on their 2010 returns.

On its website, the IRS has posted deduction tips for taxpayers planning to make contributions to aid Haitian earthquake victims.

California - At this time, California does not conform to the accelerated deduction for Haiti contributions but did enact conformity when similar federal legislation was passed in regards to Indian Ocean tsunami contributions.  It is anticipated that California will likely conform.

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Direct Deposit Puts Your Money in Your Pocket...Faster

Don’t wait around for a paper check. Have your federal tax and state (if applicable) refund deposited directly into your bank account. Choosing direct deposit is a secure and convenient way to get your money in your pocket faster.

• Secure - There is no chance for a check to get lost in the mail. Thousands of checks are returned to the IRS by the U.S. post office every year as undeliverable mail.  Direct deposit eliminates the possibility of not receiving your check and prevents your refund from being stolen.

• Convenient - The money goes directly into your bank account.  You won’t have to make a special trip to the bank to deposit the money yourself.

• Easy - Simply provide this office with your bank routing number and account number when your return is prepared, and you will receive your refund far quicker than by check.

• Multiple Options - You can also electronically direct your refund to multiple accounts.  With the "split refund" option, taxpayers can divide their refunds among as many as three checking or savings accounts and U.S. financial institutions.  Refunds can also be directed into an IRA account or used to buy Series I Savings Bonds.  A word of caution — some financial institutions do not allow a joint refund to be deposited into an individual account.  Check with your bank or other financial institution to make sure your direct deposit will be accepted.

If you need more information about direct depositing your refund or the split refund option, we can discuss your options at your tax appointment.

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To File or Not To File

A frequent question asked is whether or not an individual needs to file a tax return.  There are two issues associated with this question:

• Is there is a requirement to file?

• Should the taxpayer file even when there isn’t a requirement to file?

The answers to these two questions are quite different. You must file a tax return if your income is above a certain level. The amount varies depending on filing status, age and the type of income you receive. Different filing thresholds may apply for federal and state purposes.

For example, for 2009, a married couple both under age 65 generally is not required to file a federal return until their joint income reaches $18,700. However, self-employed individuals generally must file a tax return if their net income from self-employment was at least $400. There are special rules for children or other individuals who are, or could be, claimed as a dependent by someone else.

Even if you don’t have to file a federal return, here are six reasons why you may want to file:

• Federal Income Tax Withheld. If you are not required to file, you should file to get money back if Federal Income Tax was withheld from your pay, if you made estimated tax payments, or had a prior year overpayment applied to this year's tax.

• Earned Income Tax Credit. You may qualify for the Earned Income Tax Credit, or EITC, if you worked, but did not earn a lot of money.  EITC is a refundable tax credit meaning you could qualify for a tax refund.

• Additional Child Tax Credit. This credit may be available to you if you have at least one qualifying child and you did not get the full amount of the Child Tax Credit.

• First-Time Homebuyer Credit. If you purchased a main home during 2009 and did not own a main home during the prior 3 years, you may be able to take this refundable credit.  You may also qualify for a refundable credit if you are a long-time resident (owned the same principal residence for any 5 consecutive years during the 8-year period ending on the date of purchase of a subsequent principal residence) and purchased a main home after November 6, 2009. 

• American Opportunity Credit. The new American Opportunity Credit allows an education credit for the first four years of post-secondary education expenses. 40% of that credit is refundable even when you have no tax liability.

• Making Work Pay Credit. This is a new credit for 2009 and provides a refundable credit of up to $400 ($800 for a joint return). 

If in doubt, please call this office to see if you are required or should file a tax return for 2009. 

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A Little Help for Your Friends

In these troubling financial times, many individuals are struggling to do their own taxes.  Some need guidance with their tax and financial issues, while others would like to take advantage of the vast number of new tax benefits available in 2010 and subsequent years.

They probably do not know where to turn for professional help.  By referring them to this office, you can be assured that their individual tax needs will be looked after in the same professional manner as yours has been.

Referrals are the cornerstone of any service business.  This firm relies on satisfied clients as the primary source of new business.  Your referrals are both welcome and most sincerely appreciated!  Since your referrals are generally individuals you are well acquainted with, you can be assured that your personal, financial and tax data will not be shared with them.

Thank you for allowing this firm to be of service.

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What's Best…Tax-Free or Taxable Interest Income?

A frequent tax strategy question is whether it is better to invest for tax-free or taxable interest.  Generally, taxable interest will provide the greater return, but this may not hold true after taking into account taxes on the income.  Therefore, the question is really which provides the greater "after-tax" return.  Generally, interest derived from “municipal bonds” is tax-free for federal purposes and also tax-free for a particular state if the bonds are issued by that state or its local governments.  In addition, interest from U.S. Government Bonds cannot be taxed by any state.

The following are issues related to making a decision on taxable or tax-free income:

• Municipal bond interest. Interest earned from general purpose obligations of states and local governments, which are issued to finance their operations, are generally tax-exempt for Federal purposes.  However, the various states usually only exempt interest from bonds issued from the state itself and local governments within the state.  Hence, there are two categories of municipal bonds, namely the tax-free Federal and state and the tax-free Federal only.  Individuals can invest in municipal bonds by directly purchasing a bond or through funds that invest in municipal bonds.  Some funds invest in bonds issued in a particular state only, providing residents of that state with income that is excludible on their state’s return.

In general, tax-free bonds are likely to be more attractive for taxpayers in higher brackets, since they receive a greater benefit from excluding interest from income. For lower-bracket taxpayers, on the other hand, the tax benefit from excluding interest from income may not be enough to make up for the lower interest rate generally paid on this type of bond.

Even though municipal bond interest isn't taxable, it must be shown on the return. This is because tax-exempt interest is taken into account when determining the amount of social security benefits that is taxable, and may affect the alternative minimum tax computation, as well as the earned income credit, investment interest deduction and sales tax deduction.

• Tax-deferred retirement accounts. It generally doesn't make sense to buy and hold municipal bonds in your regular IRA, Keogh, or 401(k) plan account.  The income in these accounts is not taxed currently, but once you start making withdrawals, the entire amount withdrawn is likely to be taxed even though it includes income from tax-free sources.  Thus, if you want to invest your retirement funds in fixed income obligations, it is generally advisable to invest in higher-yielding taxable securities.

• Alternative minimum tax consequences.  Even though interest on municipal bonds is generally excluded from income for purposes of the regular federal income tax, interest on certain “private activity bonds” is included in income for purposes of the alternative minimum tax.  Your broker can tell you whether the particular bond you are considering is a private activity bond subject to this rule.

The alternative minimum tax is a separate tax system that applies if the tax determined under that system exceeds your regular income tax.  Whether or not the alternative minimum tax applies will depend on your overall tax picture; however, in general, the effect of the alternative minimum tax would be to prevent you from achieving too low an effective tax rate by means of tax-favored techniques, such as investing in municipal bonds.  This office can help you determine how the alternative minimum tax would apply to your situation, and how it would affect the after-tax yield if you were to invest in municipal bonds.

• Effect of exempt interest on taxation of Social Security benefits. In general, a portion of Social Security benefits is taxable if your adjusted gross income, subject to certain modifications, exceeds specified amounts.  For this purpose, the modifications to adjusted gross income include adding in tax-exempt interest.  The effect of this rule is that, if you receive Social Security benefits, investing in municipal bonds could increase the amount of tax you have to pay with respect to your Social Security benefits.  While technically, the municipal bond interest remains exempt from tax, the effect is the same as though a portion of that interest were taxable.  One technique to solve this problem is to invest in tax-deferred, rather than tax-free, investments.  For instance, income earned by an annuity is not taxable until the annuity is cashed in, and thus would not impact the Social Security taxation except in the year cashed in.  This office can assist you in determining the impact of tax-free income on the taxability of your Social Security benefits.

• Effect of exempt interest on earned income credit. If you are otherwise eligible to take an earned income credit, you will lose the credit completely for 2009 and 2010 if you have more than $3,100 of “disqualified income,” generally, interest, dividend, non-business rental, passive, and capital gain net income.  Disqualified income includes tax-exempt income.  Thus, municipal bond income could cause loss of the credit.  However, in most cases, an individual who's eligible for the earned income credit will be in a low tax bracket, thus making municipal bonds an unattractive investment in view of their lower yield.  Disqualifying income can be avoided by using tax-deferred investments as discussed under Social Security Benefits above.

• No deduction for interest on obligations incurred in connection with tax-exempt investments. If you borrow money for the purpose of investing in municipal bonds, you can't deduct the interest expense with respect to that borrowing.  Moreover, even if the proceeds of borrowing aren't directly traceable to tax-exempt investments, interest deductions could be disallowed if the IRS could establish that you continued the borrowing in effect (that is, you didn't pay it off) for the purpose of acquiring or carrying the municipal bonds.  

• No deduction for investment expenses related to tax-exempt investments. If you itemize your deductions, you may deduct the costs of investment advisory, custodial or agency fees, if your total miscellaneous deductions exceed 2% of your income.  However, if the investment management services you paid for are connected to the account from which you receive tax-exempt income from municipal bonds or bond funds, the related expenses are not deductible.

• Sale, call or redemption of bond. Normally, the sale, call before maturity, or redemption of a municipal bond is treated the same as a taxable bond.  If you held the bond long enough, any gain is taxed at favorable rates.  Capital losses can be used to offset other capital gains.  Up to $3,000 of any remaining losses can generally be applied against other income, with a carryover of any excess to later years. 

• U.S. government bond interest. By Federal law, the interest income of direct obligations of the U.S. government cannot be taxed by the states (but it is federally-taxed).  This includes interest from U.S. Savings Bonds, U.S. Treasury bills, notes, bonds, or other obligations of the United States.  Interest earned from the Federal National Mortgage Association (Fannie Mae), Government National Mortgage Association (Ginnie Mae) and the Federal Home Loan Mortgage (FHLMC) Corporations are not direct obligations of the U.S. government, and therefore, are not excludable from state taxation unless specifically allowed by state law (generally not the case).  If you reside in a state with no state income tax, U.S. government bond interest provides no tax benefit.

• Itemized deductions. If you do have a state tax and the investment is tax-free in your state, then it also makes a difference whether or not you itemize your deductions on your Federal return.  When you do itemize deductions, the state income tax you pay is included as a deduction on your Federal return.  Since having state tax-free income reduces your state tax, the reduced state tax lowers your itemized deductions and increases your Federal tax.

• Municipal bond funds. If you are looking for diversity and professional management for your municipal bond holdings, you may want to consider buying shares of a fund that invests in tax-exempt municipal bonds.  These funds may be broadly based or targeted to the bonds of a particular state.  Dividends municipal bond funds are treated essentially the same as municipal bond interest.  To preclude a potential tax loophole, if an investor buys fund shares, receives an exempt-interest dividend, and then sells the shares at a loss within six months after the purchase, the loss is disallowed to the extent of the exempt-interest dividend.

Use the worksheet below to determine the tax-exempt interest equivalents for your particular tax bracket, state tax (if applicable), and type of tax-exempt in investment.  Enter all rates in decimal format.  For example, 5.75% would be entered as .0575.  Carry all calculated values to at least 4 places after the decimal.



Please call this office if you would like assistance deciding whether to make a taxable or tax-free investment.  Making the right decision for your particular circumstances can have a significant effect over long periods of time.

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Tax Breaks for Charity Volunteers

If you volunteer your time for a charity, you may qualify for some tax breaks.  Although no tax deduction is allowed for the value of services performed for a charity, there are deductions permitted for out-of-pocket costs incurred while performing the services.  The normal deduction limits and substantiation rules also apply.  The following are some examples:

• Away-from-home travel expenses while performing services for a charity, including out-of-pocket roundtrip travel cost, taxi fares, and other costs of transportation between the airport or station and hotel, plus lodging and meals are allowed at 100%.  Unlike other areas of taxes, meals are not subject to the 50% limitation.  These expenses are only deductible if there is no significant element of personal pleasure associated with the travel, or if your services for a charity do not involve lobbying activities.  Any "significant element of personal pleasure" negates a deduction (i.e., not even partial deduction is allowed).  Significant personal pleasure is assumed if the taxpayer has only minor duties and is not required to perform any duties for the charity for major portions of the away-from-home stay.

• The cost of entertaining others on behalf of a charity, such as wining and dining a potential large contributor (but the cost of your own entertainment or meal is not deductible).

• If you use your car while performing services for a charitable organization, you may deduct your actual unreimbursed expenses directly attributable to the services, such as gas and oil costs, or you may deduct a flat 14 cents per mile for the charitable use of your car.  You may also deduct parking fees and tolls. 

• You can deduct the cost of the uniform you wear when doing volunteer work for the charity, as long as the uniform has no general utility.  The cost of cleaning the uniform can also be deducted.

No charitable deduction is allowed for a contribution of $250 or more unless the contribution is substantiated with a written acknowledgment from the charitable organization.  To verify your contribution:  

• Get written documentation from the charity about the nature of your volunteering activity and the need for related expenses to be paid.  For example, if you travel out-of-town as a volunteer, request a letter from the charity explaining why you're needed at the out-of-town location.

• Submit a statement of expenses if you are out-of-pocket for substantial amounts and, preferably, a copy of the receipts to the charity.  Also arrange for the charity to acknowledge in writing the amount of the contribution.

• Maintain detailed records of your out-of-pocket expenses – includes receipts plus a written record of the time, place, amount and charitable purpose of the expense.

Please call us if you have questions related to your volunteer expenses or any other charitable contributions.

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Little-Known - But Important - Credit Card Rules for Merchants

Businesses that accept credit and debit cards must comply with privacy laws that aim to protect customer identity.  There are regulations that even the most seasoned of merchants aren't always aware of.  It's important for merchants, as well as consumers, to be aware of these little-known credit card rules to protect themselves and their information.

Stay Compliant with Federal Laws - The Fair Credit Reporting Act is the federal law that establishes the foundation of consumer credit rights. This law regulates the collection and use of consumer credit information by merchants. 

Passed as an amendment to the Fair Credit Report Act, the Fair and Accurate Credit Transaction Act prohibits merchants from showing credit card numbers on receipts.  To comply with this law, businesses must truncate credit card information on electronically printed receipts.  Merchants can include no more than the last five digits of the card number and must delete the card's expiration date.

Example: ACCT: **********00714
                   Exp: **-**

The law does not apply to imprinted or handwritten receipts; however, merchants using these are also required to protect customer identity. For more information, check out the Federal Trade Commission's guide Slip Showing?

Comply with State Laws

After complying with the Fair Credit Reporting and Accurate Credit Transaction Act, be sure to familiarize yourself with your state's laws on the use of consumer credit information. 

Many states have laws that establish what kind of information merchants can and cannot ask for or write down when a customer uses a credit card. For example, California prohibits merchants from requesting or requiring that a consumer write any personal information (like their address or telephone number) on any form associated with their credit card transaction.

Not all states have additional laws that specifically regulate credit card practices.  For more information, read more about state merchant laws*, or check with a small business expert in your state. 

Beyond the Law - Merchant Contracts

Beyond these government regulations, credit card practices are also policed by the credit card companies themselves through terms of service or rules manuals.  These agreements details how transactions using their cards should be carried out.

Interestingly, many merchants cannot require a customer to provide identification as a requirement for accepting a credit card.  Although a merchant is allowed to ask for identification, customers can refuse without suffering a penalty.  The rules manual for popular cards like Visa or MasterCard state that a merchant must accept their card regardless of whether or not the customer provides personal identification. Note: If a customer prefers to be asked for identification, they can write "See I.D." or "Ask for I.D." on the back of their card. Although merchants are not required to follow this request, many happily comply.

Another little-known, but common, rule is that credit card companies generally prohibit merchants from establishing a "minimum purchase amount" when processing transactions with their cards. It is very common to walk into a store and see a sign stating that credit card transactions require a $10 minimum purchase.  Credit card companies want to promote the use of their cards and usually include rules that prohibit merchants from making these statements. More often than not, these merchants are violating their processing agreement with their card companies. Official rules vary from card to card but it is safe to say that it is either strongly discouraged or explicitly prohibited in many agreements. Unfortunately, for small businesses, transaction fees often mean that a small purchase made on a credit card hurts their profits.  

It is not uncommon for merchants to ignore aspects of their rules manuals, usually because many are unaware the rules even exist.  Businesses should be sure to review the rules manuals for each company whose card they accept as payment.  Consumers should do the same to be aware of the rights they have for each card they carry.

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Owner-Only Businesses Should Consider a Solo 401(k) Plan

It goes by many names: Solo 401(k), Mini 401(k) and single-participant 401(k).  We will use Solo 401(k) in this article to describe probably the best type of pension plan for owner-only businesses.  It provides for larger contributions, including a Roth option for a portion of the contribution, and the ability to borrow funds from the plan at reasonable rates.  As a result, Solo 401(k) plans have become more attractive options than SEP-IRAs, Simple IRAs or profit-sharing or money purchase plans.  In addition, if the plan permits and most do, assets for other retirement plans can be rolled over into the Solo 401(k) plan.  

Generally, Solo 401(k) plans are a natural fit for two categories of businesses.  The first includes independent contractors, sole proprietors, and owner-only C or S corporations. The second is those who have dual incomes.  They are W-2 wage earners employed by a company that offers a 401(k) plan who also have consulting income from corporate directorships or freelance work that requires them to file a Schedule C as a sole proprietor.  Since the 401(k) contribution limits apply to each individual for the year and not the individual plans, if the taxpayer has multiple 401(k) plans, he or she needs to make sure that not more than the annual limit is contributed to the combination of plans.

For 2010, the rules limit employer contribution (profit-sharing contribution) to 25% of compensation.  The employee can also make salary deferral contributions up to $16,500.  Together, these contributions cannot exceed the lesser of $49,000 or 100% of compensation.  In addition, if the employee is age 50 or over, he or she can make an additional catch-up contribution of $5,500. 

Example – Susan Lewis, age 49, is the sole employee of an incorporated business. Her earned income is $100,000 in 2010. Under the law, Susan can contribute $25,000 to a SEP-IRA ($100,000 x .25), $14,500 (11,500 plus 3% of $100,000) to a Simple IRA, or $25,000 to a profit-sharing or money purchase plan.  However, she can contribute $41,500 to a Solo 401(k) plan ($25,000 employer contribution plus $16,500 employee deferral), still under the $49,000 maximum for the year. If Susan were age 50 or over, she could also make a catch-up contribution of $5,500, increasing her 401(k) contribution total to $47,000.  

Note: Generally, 401(k) plan contributions for an unincorporated business will be slightly lower than the above amounts. For unincorporated businesses, compensation is net profit minus half of self-employment taxes minus employer contributions.

Although Solo 401(k) plans are limited to the business owner and his or her spouse, business owners should note the added benefits of having his or her spouse as the business’s only other employee.  Having the spouse on the payroll gives the business owner the opportunity to shelter some or all of his or her income by having the spouse make an elective deferral to a 401(k) plan in addition to the business making a profit-sharing contribution.  Although the spouse and the business would be responsible for their respective share of employment taxes on the salary, combined employer and employee contributions can be up to the lesser of $49,000 (for 2010) or 100% of compensation. This limit applies separately to the business-owner and spouse, thus allowing a combined total of up to $98,000 (for 2010).  In addition, if age 50 or over, each individual could defer an additional $5,500 each year.

Potential downside - If a business grows and begins hiring employees, the Solo 401(k) plan must become a full-blown 401(k) plan subject to other more stringent rules including discrimination testing that can serve to limit contributions by highly-paid executives.  Many providers recommend that businesses with immediate expansion plans not set up one of the Solo 401(k) arrangements.  Caution: If the business owner has other businesses or is part of a controlled group of corporations, partnerships, proprietorships or affiliated service groups, the employer aggregation rules may apply and the employees of those other businesses may have to be considered for purposes of meeting qualification and minimum coverage requirements for the Solo 401(k).

For additional information regarding Solo 401(k) plans and how it might fit into your tax strategy and retirement planning, please give this office a call.  If you are considering a Solo 401(k) plan for 2010, be aware that the plan must be set up before year’s end.

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Are You Supporting Your Parents?

If you are helping support your parents, you may be having difficulty showing over half of the support for both, thus failing to qualify for the dependency exemptions (and for the beneficial head of household filing status if you are a single taxpayer).

You may overcome this problem by designating the support to only one of the parents.  This may allow you to claim at least one of the parents as your dependent and, if you are unmarried, allow you to file as head of household.

To qualify for the head of household filing status, a taxpayer must maintain a household that constitutes one or both of his or her parents' principal abode, and at least one of the parents must be the taxpayer's dependent, i.e., must individually have gross taxable income for the year of less than the personal exemption amount ($3,650 for 2009 and 2010) and receive over half of his or her support from the taxpayer.  The taxpayer himself need not reside in the household he or she maintains for the parents.  The home could even be a retirement home or facility.

To accomplish this, the taxpayer must be able to provide proof that the support is for one of the parents only.  Otherwise, the support will be designated as a “fund” equally allocated to both.  The IRS suggests a notation on a check as an acceptable designation procedure.  It says, “Notations by the maker on support checks purporting to allocate funds to particular household members made payable to an individual having custody of a claimed dependent, will be regarded as evidence of actual support.”

Although having no effect on filing status, when several people together provide over 50% of support, all who provide more than 10% of the support can agree about which of them will claim the dependent.  Of course, the agreeing parties must also otherwise qualify to claim the dependent.  Each person who is relinquishing the dependent exemption must complete an IRS Form for attachment to the return claiming the dependent.

If you are supporting both parents and would like to discuss how the foregoing might apply to your specific situation, please give this office a call.

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