Did you receive a substantial refund from your 2005 taxes? If you did, you are one of a large number of taxpayers who are giving Uncle Sam interest-free loans. Granted, interest rates have been pretty low for the past few years, but they are gradually increasing, so you might want to consider reducing your withholding to the point that it more closely approximates your anticipated tax liability.

Some taxpayers use excess withholding as a forced means of saving for other annual expenses, such as property taxes and vacations. The same result could be accomplished by turning the excess withholding into automatic withdrawals for credit union or bank deposits where the interest earnings will go into your pocket, not to the government. The larger the refund, the bigger an issue this becomes.

If you need to adjust your withholding amount or are concerned that you might be subject to an underpayment penalty for 2006, then please call our office for assistance. We are here to help.

We are in an age where advertising dominates the television, radio and magazines. Ads fill up your mail box, and even the daily newspaper contains more ads than news. All these ads are doing their best to tempt us into buying goods and services. When it comes down to it, it’s all about making the right choices.

It used to be that individuals worked hard to pay off their home mortgage. These days, we are bombarded with advertisements from lenders suggesting that money be pulled out of the home for things we want but may not really need. Paying for things from future income is risky and can get you into financial difficulty in your retirement years.

Please give us a call if you need assistance with planning for your retirement, your children’s college education, or would like to discuss available tax planning strategies.

That is because, before the 2001 Tax Act, IRA accounts generally could not be rolled over from an IRA into a qualified plan, such as a 401(k) qualified retirement plan, a 403(a) annuity plan, a 403(b) tax-sheltered annuity, or a 457 government plan.

It is now allowed and can provide some interesting planning opportunities. However, there is a possible fly-in-the-ointment. Qualified plans are not required by law to accept funds from IRA accounts, so you first need to check with the plan administrator to see if your plan will accept IRA funds before attempting any of the strategies outlined below. The rollovers are also limited to the taxable portion of the IRA, thus the nondeductible portion of the contributions cannot be rolled into a qualified plan.

Early Retirement – Generally, except for some special exceptions, if a taxpayer withdraws funds from an IRA account before reaching the age of 59½, the withdrawal is subject to a 10% early withdrawal penalty (in addition to normal tax). However, a withdrawal from a qualified plan made after age 55, accompanied by separation from employment service, is exempt from the penalty.

Thus, the funds can be withdrawn 4½ years earlier without incurring the 10% penalty. Although penalty-free early retirement withdrawals are available from IRAs, they include some withdrawal limitations that do not apply to the age 55 exception, which provides more flexibility.

Nondeductible IRA Contributions – As we mentioned earlier, the portion of a Traditional IRA that represents nondeductible IRA contributions (and which are nontaxable) cannot be rolled into a qualified plan. And, if distributions were taken from an IRA that includes nondeductible contributions, you don’t receive the nontaxable portion first. Instead, any distribution is prorated on the basis of the deductible and the nondeductible portions.

We can, however, take the entire nondeductible contribution out of the IRA virtually tax-free and penalty-free if we roll over the taxable portions (the law precludes a taxpayer from rolling the nondeductible portion) of the IRA into a qualified plan, leaving only the nondeductible portion in the Traditional IRA. In addition, if a distribution includes both taxable and nontaxable amounts, the amount rolled over is treated as coming first from the taxable part of the distribution. Thus, when a distribution is subsequently made from the IRA, all funds (except for earnings after the rollover) are nontaxable and not subject to tax or the 10% penalty.

Roth Rollovers – Using the same scenario from the nondeductible IRA above, if the taxpayer otherwise qualifies, he or she could (after the waiting period described below) roll the nontaxable portion into a Roth IRA with virtually no tax liability. Thus, the future earnings from the Roth IRA would end up being tax-free and that portion of the former IRA would pass to the beneficiary tax-free.

As with everything, there are some rollover rules. Generally, if a taxpayer makes a tax-free rollover of any part of a distribution from a Traditional IRA, he or she cannot, within a one-year period, make a tax-free rollover of any later distribution from that same IRA. The taxpayer also cannot make a tax-free rollover of any amount distributed, within the same one-year period, from the IRA into that which he or she made the tax-free rollover. The one-year waiting period can be avoided by using Trustee-to-Trustee Transfers instead of a rollover. It accomplishes the same objective, but because the taxpayer never had access to the funds, it is not subject to the one-year waiting period required between rollovers.

Please call this office so we can assist you in developing a plan to fit your particular circumstances.

The recent hurricanes, tsunamis, and terrorist attacks make it clear that even smaller companies are not immune to an unexpected loss. What can you do to prepare and minimize your risk to ensure that such a disaster won’t run you out of business?

Unplanned events can have a devastating effect on your business. You need to be protected from any number of natural and unnatural events such as fire, computer failure, and illness of key staff, all of which can make it difficult or even impossible to continue day-to-day operations.

Good planning can help you take steps to minimize the impact of a disaster and protect your business. The following recommendations can help your business cope with an unforeseen calamity.

Why the Need to Plan?
By identifying possible disasters that may affect you and your business, you may be able to minimize the risks and losses that might occur. A well thought-out business continuity plan will identify an action plan, safety concerns, applicable computer back-ups, and alternative operation headquarters. It will also provide a road map back to normal activities by highlighting the points of contact for insurance and emergency relief way ahead of time.

Educate Your Staff.
How will you escape? Where will you meet up? How will you communicate? Map out and practice escape routes from your building. Familiarize yourself with local authorities and emergency radio signals announced at the time of a disaster. What happens if you survive the disaster but your biggest supplier does not? Develop back-up vendors and relationships ahead of time.

Don’t forget that many employees will have families to care for and may have their homes affected by the disaster. Have you stockpiled water, batteries, first aid kits and food in case emergency services are delayed?

Back Up Key Business Information.
Does your computer system have a nightly back-up tape? If the answer is yes, where are the back-up tapes stored? And more importantly, will the back-ups include all of the software needed for your computers to function at another location? Many businesses now have outside vendors that host and back up their computer systems for them. Inquire if they have redundant back-up systems and request information on their emergency plans.

If the disaster is only temporary and shuts down the electrical grid to your business, a generator may be a sound investment. The generator can power your computer system, equipment, refrigerators, and other items that might be crucial.

Review Your Insurance Coverage.
As many realize after the fact, they are not insured for many natural disasters under their existing business policy. You may need to add or increase coverage if it is available. Check with your carrier for details on your coverage.


Recovering and Government Assistance
The following government agencies may provide assistance:

• Small Business Administration (SBA) - Provides low interest loans to businesses, homeowners and renters who are victims of a disaster. They even provide loans for the replacement or repair of damaged or destroyed clothing, appliances, furnishings, and automobiles. For more information, visit their website at: www.sba.gov.

• Federal Emergency Management Agency (FEMA) - Disaster assistance is provided in the form of money or direct assistance to individuals, families and businesses in an area whose property has been damaged or destroyed and whose losses are not covered by insurance. It is meant to help with critical expenses that cannot be covered in other ways. For more information, visit their website at: www.fema.gov.

Since a disaster strikes without warning, being prepared can help your business recover more quickly from a catastrophic emergency. Take the necessary steps to ensure that both you and your business investments are well-protected.

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In legislation recently passed by Congress (“Heroes Earned Retirement Opportunities Act,” H.R. 1499), excludable (tax-free) combat pay is treated as compensation for purposes of making an IRA contribution. Under prior law, taxpayers whose entire compensation for the year was excludable combat pay could not make an IRA contribution for the year.

Generally, in any tax year, a taxpayer can make a deductible contribution to an IRA account in an amount not greater than the lesser of: (1) the annual statutory contribution limit ($4,000 or $5,000 if age 50 or older for 2006), or (2) 100% of compensation for the year. (Code Sec. 219(b)) However, if the taxpayer or spouse is an active participant in an employer plan and the AGI exceeds the phase-out threshold for the year, the deductible portion of the contribution is reduced or eliminated. For 2006, the phase-out threshold for joint filers is $75,000 ($50,000 for single or head of households). For a taxpayer who isn’t an active participant but their spouse is, the phase-out threshold is raised to $150,000. In addition, if a joint filer has compensation that is less than the contribution limit for the year, he or she can combine his or her compensation with that of their spouse (reduced by their spouse’s IRA contribution) to determine their allowable contribution for the year. (Code Sec. 219(c)).

Three-Year Window – Taxpayers who received excludable combat pay in 2004 and 2005 have a three-year window to make an IRA contribution for either or both tax years, provided they otherwise qualify. This includes spousal contributions. The three-year period begins on the date of enactment.

Tax Strategies - Taxpayers with little or no taxable income might consider making a nondeductible contribution to a Roth IRA, which provides a tax-free benefit in the future. Taxpayers who are limited in making a deductible contribution or a Roth contribution might consider making a nondeductible traditional IRA contribution and then converting the nondeductible traditional IRA to a Roth IRA in 2010, with only tax on the earnings before the conversion when the Roth conversion AGI limits have been removed.

Refunds – Because of the three-year window for making up prior year contributions, the contributions could be made after the statute of limitations for refunds has expired. The act, however, allows a credit or refund if the claim is filed before the close of the one-year period beginning on the date that the contribution is actually made. In addition, Sec 7508 provides extensions for performing certain acts while in a combat zone. Watch for IRS guidance on how those provisions will interact with the three-year rule.

Earned Income Credit (EIC) – Under another similar special rule and at the election of the taxpayer, excludable combat pay can be treated as earned income for purposes of computing the earned income credit. The special election will expire after 2006 without Congressional action.

Please call this office as soon as possible if you may be affected by this law change and would like to take advantage of its benefits.

Don’t allow yourself to become complacent just because your company uses a highly-respected payroll service. Because of the issues surrounding the court case, the IRS and the Social Security Administration offer the following advice to employers:

They strongly suggest that the address of record with IRS not be changed to that of the payroll service provider. If there are any issues with an account, the IRS will contact the employer. Changing the address may significantly limit the employer's ability to be informed of tax matters involving his or her business in a timely manner.

An employer should ask the payroll service provider if they have a fiduciary bond. This can protect the employer in the event of default.

The employer should ask the service provider to enroll in and use the Electronic Federal Tax Payment System (EFTPS). The EFTPS maintains the payment history of a business for 16 months and can be viewed online. This allows the employer to immediately confirm payments electronically, 24 hours a day, 7 days a week through the Internet or by phone. The IRS recommends employers verify EFTPS payments as part of their bank account reconciliation process.

The IRS further cautions that there have been instances of individuals and companies acting under the guise of service providers who have stolen funds intended for payment of employment taxes, leaving the employer ultimately responsible for the payroll taxes and penalties.

There are a number of options available that can be used to plan the disposition of the property to best suit the needs of the individual while minimizing the tax impact.

Outright Sale – Of course, an individual can sell the property outright and then the net proceeds will be available for other investment or spending purposes. When a rental property is sold outright, the entire gain will be taxable in the year of sale.

Whether that is good or bad depends upon whether you can offset all or part of the gain with: (1) capital loss carryovers, (2) investments that have unrealized losses that can be converted to realized offsetting losses, (3) passive loss carryovers, (4) net operating loss carryovers, (5) investment interest expenses carryovers, or (6) a combination of these situations. If the taxpayer is able to offset the gain, an outright sale may be the best option for disposing of the rental and should be considered before exploring other options.

Installment Sale – If the seller carries back a note (mortgage) for all or part of the buyer’s purchase price, the seller qualifies for installment sale treatment, which in effect spreads the taxation of the gain over the life of the note.

Let’s say that your rental is sold for $400,000 with 20% down and you carry a note for the balance. Assume that your profit is $300,000. This would mean that 75% of every dollar of principal that is received will be taxable. Therefore, in the first year, only $60,000, 75% of $80,000 (20% of $400,000) down payment plus 75% of the principal payments would be taxable. Note that in the year of sale, any ordinary income that is required to be recaptured is fully taxable, even if no payments were received.

When considering an installment sale, don’t overlook that your money may be tied up for a long period of time in a mortgage note. If the principal is not needed for other purposes, then this shouldn’t be a problem.

Convert to Personal Use – The rental can be converted for the personal use of the taxpayer and any gain deferred until the property is ultimately sold. This option presents an interesting opportunity. If the rental is residential and the taxpayer occupies the rental for at least two years after the conversion and otherwise meets the requirements, the rental would qualify for the home sale gain exclusion.

Thus, the gain, in excess of the depreciation previously claimed on the home, could be offset by the home gain exclusion. The home gain exclusion is $250,000 ($500,000 for married couple filing jointly where the spouse also qualifies). Although there are some timing issues, taxpayers can generally use this exclusion repeatedly as long as they qualify and only use the exclusion every two years.

Tax-Deferred Exchange – A tax-deferred (Section 1031) exchange can be used as a means of avoiding immediate taxation on the gain from a rental property by deferring the gain into a replacement property. To qualify for a Sec. 1031 exchange, the property that replaces the rental must be held for business or investment use and must be real estate (improved or unimproved qualifies).

Sometimes real estate is held in a partnership or other entity. Generally, an entity ownership does not qualify as like-kind, although tenant-in-common interests (sometimes referred to as TICS), if structured properly, can qualify.

If a taxpayer acquires (or constructs) property solely for the purpose of exchanging it for like-kind property, the IRS says that the taxpayer doesn't hold the property for productive use in a trade or business or for investment, and the exchange doesn't qualify for non-recognition treatment under Sec. 1031.

• Simultaneous or Delayed – An exchange can be simultaneous or delayed. If delayed, the property received in the exchange must be identified within 45 days after the property given is transferred. No matter how many properties are given up in an exchange, a taxpayer is allowed to designate a maximum of either:

(a) Three replacement properties regardless of their fair market value (FMV), or
(b) Any number of properties, as long as the total FMV isn’t more than 200% of the total FMV of all properties given up.

The receipt of the new property must be completed before the earlier of:
(a) 180 days after the transfer of the property given, OR
(b) The due date (including extensions) of the return for the year in which the property given was transferred.

• Qualified Intermediary – Generally, to qualify for a delayed Section 1031 exchange, a qualified intermediary is engaged to hold the funds from the sale until the replacement purchase is made. It is important to understand that the taxpayer cannot take possession of the proceeds from the sale and then buy another property. If that happens, the event does not qualify for exchange and is immediately taxable.

• Reverse Exchanges – It is possible to structure a reverse exchange that complies with the Section 1031 delayed exchange requirements. However, it requires that the replacement property be purchased first by the intermediary, without the benefits of the proceeds from the property given up in the exchange. Thus, only taxpayers with the cash financial resources can accomplish reverse exchanges.

Tax-deferred exchanges can be very tricky and should not be entered into without first analyzing the tax aspects.

You are cautioned not to use any of these strategies without first consulting with this office. There are certain qualifications that must be met and the information provided is only an overview.

Are you doing your summer cleaning and wondering if you can throw out some of those old tax records? If you are like most taxpayers, you have records from years ago that you are afraid to throw away. It would be helpful to understand why you keep the records in the first place.


Generally, we keep “tax” records for two basic reasons: (1) in case the IRS or a state agency decides to question the information reported on our tax returns, and (2) to keep track of the tax basis of our capital assets so when we actually dispose of them we can minimize the tax liability.

With certain exceptions, the statute for assessing additional tax is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal.

In addition to lengthened state statutes clouding the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return. And of course, the statutes don’t begin running until a return has been filed. There is no limit where a taxpayer files a false or fraudulent return in order to evade tax.

Examples - Sue filed her 2004 tax return before the due date of April 15, 2005. She will be able to dispose of most of her records safely after April 15, 2008. On the other hand, Don filed his 2004 return on June 2, 2005. He needs to keep his records at least until June 2, 2008. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

The big problem! The problem with the carte blanche discarding of records for a particular year because the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets.

They need to be separated, and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into that category:

• Stock acquisition data - If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.

• Stock and mutual fund statements – Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gain when it is finally sold. Keep statements at least four years after final sale.

• Tangible property purchase and improvement records - Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

When discarding old records, don’t forget about identity theft problems. Be sure to shed or burn the documents or portions of those documents that contain sensitive information such as Social Security Numbers, account numbers, addresses, etc.

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Generally, start-up expenses include all expenses incurred to investigate the formation or acquisition of a business or to engage in a for-profit activity in anticipation of that activity becoming an active business. To be eligible for the election, an expense also must be one that would be deductible if it were incurred after the business actually began. An example of a start-up expense is the cost of analyzing the potential market for a new product.

As with most tax benefits, there is always a catch. Congress put a cap on the amount of the start-up expenses that can be claimed as a deduction under this special election. Here’s how: If the expenses are $50,000 or less, you can elect to deduct up to $5,000 in the first year, plus you can amortize the balance over 180 months.

If the expenses are more than $50,000, then the $5,000 first-year write-off is reduced dollar-for-dollar for every dollar start-up expenses exceed $50,000. For example, if start-up costs were $54,000, the first-year write-off would be limited to $1,000 ($5,000 – ($54,000 - $50,000)).

The election to deduct start-up costs is made by claiming the deduction on the return for the year in which the active trade or business begins, and the return must be filed by the extended due date.

On Schedule C, the deduction is taken as part of the “Other Expenses” in Part V. If the entire amount of start-up costs isn’t deductible in the business’ first year, use Form 4562 to amortize the excess amount over 180 months.

Qualifying Start-Up Costs – A qualifying start-up cost is one that would be deductible if it were paid or incurred to operate an existing active business in the same field as the new business, and the cost is paid or incurred before the day the active trade or business begins. Not includible are taxes, interest or research and experimental costs. Examples of qualified start-up costs include:

• Surveys/analyses of potential markets, labor supply, products, transportation facilities, etc.;
• Wages paid to employees and their instructors while they are being trained;
• Advertisements related to opening the business;
• Fees and salaries paid to consultants or others for professional services; and
• Travel and other related costs to secure prospective customers, distributors, and suppliers.

For the purchase of an active trade or business, only investigative costs incurred while conducting a general search for or preliminary investigation of the business (i.e., costs that help the taxpayer decide whether to purchase a new business and which one to purchase) are qualified start-up costs. Costs incurred attempting to buy a specific business are capital expenses that aren’t treated as start-up costs.

Please call this office if you have further questions.

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When looking for deductions to add to your taxes, don’t overlook your meal and entertainment expenses. These types of expenses must be “ordinary” and “necessary” to your business or trade and must be “directly related to” or “associated with” the active conduct of business.

In order for the IRS to allow these deductions, good documentation is a requirement and should include the amount, date, time and place, business purpose and names of guests and business relationship.

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Generally, improvements you make to your home are not currently deductible and can only be used to offset any gain from your home when you sell it. However, that is not the case for medically necessary home improvements which can be taken as a medical deduction on your tax return. Such improvements include ramps for wheelchair access, a lift or elevator and rails for a handicapped person, or a therapy spa for an arthritis sufferer.

The costs of such expenses are deductible as a medical expense to the extent the expense exceeds any resulting increase in value of the property.