With individuals living longer, we frequently find ourselves in the position of a caregiver for elderly or incapacitated individuals. Whether it be an incapacitated or elderly spouse, an elderly parent or even a child, there are tax implications that need to be considered and can relieve some of the financial burden associated with being a caregiver. The following are some tax aspects of taking on the care of an elderly or incapacitated individual.

Dependency exemption. You may be able to claim the cared-for individual as your dependent, thus qualifying for an exemption. To qualify;

• You (1) must provide more than 50% of the individual's support costs,
• The individual must either live with you or be related,
• The individual must not have gross income in excess of the exemption amount ($3,300 for 2006),
• The individual must not himself file a joint return for the year, and
• The individual must be a U.S. citizen or a resident of the U.S., Canada, or Mexico.

(1) If the support test can only be met by a group (several children, for example, combining to support a parent), a “multiple support agreement” form can be filed to grant one of the group members the exemption, subject to certain conditions.

Medical expenses. If the cared-for individual qualifies as your dependent (2) or medical dependent, you can include any medical expenses you incur for the individual along with your own when determining your medical deduction.

Amounts paid to a nursing home are fully deductible as a medical expense if the principal reason that a person stays at the nursing home is for medical, as opposed to custodial, etc., care. If a person isn't in the nursing home principally to receive medical care, then only the portion of the fee that is allocable to actual medical care qualifies as a deductible medical expense. But if the individual is chronically ill, all of the individual's qualified long-term care services, including maintenance or personal care services, are deductible.

(2) A medical dependent is an individual who doesn't qualify as your dependent only because of the gross income or joint return test; you can still include these medical costs with your own.

Reverse mortgage as alternative to nursing home. It is often desirable for an elderly person to remain in his or her own home with proper in-home care rather than entering a nursing home. A reverse mortgage loan may make this a feasible alternative to a nursing home. If this approach is taken, don’t forget the household help is deductible in the same manner as the nursing home. In addition, household employees must be paid by payroll.

Filing status. If you aren't married, you may qualify for “head of household” status by virtue of the cared-for individual. If the cared-for individual: (a) lives in your household, (b) you pay more than half the household costs, (c) the individual qualifies as your dependent, and (d) is a relative, you can claim head of household filing status. If the person you're caring for is your parent, he or she does not need to live with you, as long as you provide more than half of the household costs and he or she qualifies as your dependent. For example, if a parent is confined to a nursing home and you pay more than half the cost, you are considered as maintaining a principal home for your parent.

Dependent care credit. If the cared-for individual qualifies as your dependent, lives with you, and physically or mentally cannot take care of themselves, you may qualify for the dependent care credit for costs you incur for their care to enable you and your spouse to go to work.

Exclusion for payments under life insurance contracts. Any lifetime payments received under a life insurance contract on the life of a person who is either terminally or chronically ill are excluded from gross income. A similar exclusion applies to the sale or assignment of a life insurance contract to a person who regularly buys or takes assignments of such contracts and meets other qualifying standards.

If you are a caregiver and would like to discuss your situation further, please call this office.

A CRT, otherwise known as a Charitable Remainder Trust, is a potent estate planning tool. It is meant for individuals who wish to leave some portion of their estate to charity after they pass away, but while they are still living, enjoy a substantial charitable deduction and income stream. In order to achieve tax benefits from a CRT, it must be an irrevocable trust. This means you can’t change your mind later.

Here is how it works:

• A portion of your assets is contributed to the trust. The trust manages those assets and makes payments (at least annually) to you, typically until you pass away.
  
  
• The trust pays no taxes on its income. Thus, it can sell an appreciated asset and pay no income tax on the gain. It produces a higher rate of investment return which, in turn, allows larger payments to you.
  
  
• When you pass away, the remaining assets in the trust pass to your pre-designated charities. Thus, the name “charitable remainder trust” was coined.
  
  
• In addition, you will receive a current charitable deduction for an amount equal to the estimated remainder in the trust at the time of your death.

Since the remainder will pass to one or more qualified charities upon your death, the trust will be eligible for the estate tax charitable deduction. You might even consider using some of the savings from the charitable contribution to purchase life insurance for the benefit of your heirs.

Let’s do a recap of all its benefits. You have reduced your estate, provided an income stream, and received a large up front charitable deduction, even though the charity has to wait until you pass away to receive anything from your estate. Not bad at all!

Although Charitable Remainder Trusts can be very complex, the benefits generally make them a viable planning tool. Please call this office if we can be of assistance.

In taxes, there is a saying: “Those who keep records win.” If you are an investor, you may have a variety of securities, including stocks, bonds, mutual funds, etc. When you sell those securities, you want to minimize your gains or maximize your losses for tax purposes. Gain or loss is measured from your tax basis in the investment (asset), which makes it important to keep track of the basis in all your investments.

What is Basis? Generally, your basis in an investment begins with the price that was paid to purchase the investment. However, that will not be the case if the investment was acquired by gift or inheritance. For inherited assets, the basis generally begins with the FMV of the asset on the decedent’s date of death or an alternative valuation date, if chosen by the executor of the estate. Assets acquired by gift actually have a basis for gain - the donor’s basis - and a basis for loss - the fair market value of the asset on the date of the gift. When an asset is acquired through a division of property in a divorce, the asset retains the basis it had when it was owned jointly by the couple.

Basis is not a fixed value; it can change during the time the asset is owned and is adjusted by certain events. For an investment asset, these events include:

• Reinvested cash dividends,
• Stock split and reverse splits,
• Stock dividends,
• Return of capital,
• Additional investments,
• Broker’s commissions,
• Interest previously taken into income under an election under the accrued market discount rules,
• Interest taken into income under the original issue discount rules,
• Attorney fees,
• Acquisition costs,
• Depletion,
• Casualty losses, etc.

These events can increase or decrease the tax basis in the investment, which makes adequate recordkeeping so important.

Another issue associated with basis is when a portion of the investment is sold. Let’s say 100 shares of a particular stock were purchased in 2001 at $10 a share and another 100 shares in 2003 at $20 a share. The investor plans on selling 100 shares of the stock at $30 a share. Using the general rule of “first in - first out,” there would be a $20 per share gain. However, if the investor can identify each specific block of stock sold, such as the 100 share block bought in 2003, there would only be a $10 per share profit. This is known as the “specific identification” method.

The following is a discussion of the more commonly encountered basis adjustments where recordkeeping is essential:

Reinvested cash dividends – Investors are frequently given the opportunity to reinvest their dividends instead of taking them in cash. By participating in these plans, they are actually purchasing additional sales with their taxable dividends. Unless records are kept, the investor can’t prove how much he or she paid for the shares or establish the amount of gain that is subject to tax (or the amount of loss that can be deducted) when it is sold
.

Stock dividends – It is possible to receive both taxable and nontaxable stock dividends. Stock dividends that are taxable provide the investor with additional stock with a basis equal to the taxable stock dividend. If the dividends are nontaxable, the number of shares that are owned increases, but the basis remains unchanged. If the investor can associate the dividends with a specific block of stock, then the basis of that block can be adjusted accordingly. If not, the adjustment will apply to the entire holdings in that particular stock.

Return of capital – A return of capital is a nontaxable return of a portion of the investment. Thus, a return of capital will reduce the investor’s basis in security. Suppose an investor has 100 shares of XYZ Corporation that cost $1,000 ($10 per share), and the corporation distributes to him a $100 nontaxable return capital. His basis in the stock is reduced to $900 ($1,000 - $100) or $9.00 per share. If, over a period of time, the return of capital exceeds his basis in the investment, then the excess becomes taxable because he cannot have a negative basis.

Stock splits – Stock splits can be confusing if they are not tracked as they occur. Let’s assume that an investor owns 100 shares of XYZ Corporation for which he paid $2,000 ($20 a share). Later on, the corporation splits the stock 2 for 1. The result is that he now owns 200 shares, but his basis in each has been reduced to $10 per share (200 shares times $10 equals $2,000 – what was paid for the original shares). This generally occurs when the “per share value of stocks” becomes too high for small investors to purchase 100 share blocks. Also watch for reverse splits, which have the opposite effect.

Stock spin-off – Occasionally, corporations will spin-off additional companies. The most classic example is the break up of AT&T some years ago into regional phone companies, who themselves later split into additional companies or merged with others. Each time one of these transactions take place, the corporation will provide documentation on how to split the prior basis between the resulting companies. Tracking these events as they happen is very important, as it may be difficult to reconstruct the information several years down the road.

Broker fees – Although broker fees are a deductible expense, they are generally already accounted for in most stock and bond transactions. The purchase price of a block of stock generally includes the broker fees, and the sales price reported to the IRS (gross proceeds of sale) is the net of the sales costs.

Depending upon the investment vehicle, tracking the basis in an investment can be quite complicated. If you have questions, please contact this office.

If you have never been solicited to purchase a vacation timeshare, you are probably in the minority. You will see these invitations in your mailbox offering a free visit to a resort location. In return, you will be required to attend a sales presentation as part of the free offer. If you go on vacation quite often, you may also be offered a meal credit or other incentive to attend a sales presentation. High pressure tactics will be used during these presentations, so avoid it if you are easily persuaded.

For some individuals who actually use their annual purchased time at the resort, it might provide a great benefit. For others, it might be something they will live to regret. Let’s look at the tax and financial aspects of owning a timeshare.

Characteristics – Timeshare ownership is usually purchased in units of a week per year, two being the most common, and for a specific number of years such as 20, 25, or 30. In addition, the ownership can be for high-demand times of the year or for the less desirable weeks.

Marketability – The resale market for timeshares is very slow, and the units that do sell are for a fraction of the original purchase price. This is especially true of the older timeshares with fewer weeks remaining in contract. There is also a vast number of timeshares entering the market with newer and more modern facilities. Also keep in mind that there are so many opportunists out there ready to separate you from a nonrefundable appraisal fee or other up-front fees before the units are sold.

Maintenance Fees – Virtually all timeshares come with an annual maintenance fee. Be careful about maintenance fees that have limits to their annual increase. You want the timeshare to be maintained, but you don’t want to feather someone else’s bed either. These annual fees are generally not deductible for tax purposes.

Interest – Generally, interest to acquire a taxpayer’s primary home and one annually designated second home is deductible as home mortgage interest. Thus, if the taxpayer’s mortgage limit has not been exceeded, the interest paid to finance the purchase of the timeshare is deductible as home mortgage interest for those taxpayers that itemize their deduction.

Sales Consequences – Since timeshares are considered personal-use property (not investment), any loss from the subsequent sale of the timeshare units would not be tax-deductible. On the other hand, gain from the sale of the timeshares would be taxable.

So, if you decide to acquire a timeshare, you might consider looking at units for resale within the resort you are interested in. Chances are you can purchase a unit far below the normal asking price. Please call this office if you have questions about the tax ramifications of timeshare ownership.

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Congress considers our tax system as a "pay-as-you-go" system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the "pay-as-you-go" requirement. These include:

• Payroll withholding for employers;
• Pension withholding for retirees; and
• Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This penalty is 2% higher than the prime rate, and the penalty is computed on a quarter-by-quarter basis.

Federal tax law does provide ways to avoid the underpayment penalty. If the underpayment is less than a de-minimis amount, no penalty is assessed. The de-minimis amount is $1,000. This means, if you owe $1,000 or less on your tax return, you will not be subject to the federal underpayment penalty. In addition, the law provides "safe harbor" prepayments. There are two safe harbors:

The first safe harbor is based on the tax you owe in the current year. If your payments equal or exceed 90% of what you owe in the current year, you can escape a penalty.

The second safe harbor is based on the tax you owed in the immediately preceding tax year. If your payments equal or exceed 110 % of what you owed in the prior year, you can escape a penalty.


Example: Suppose your 2006 tax is $10,000, and your 2006 prepayments total $5,800. The result is that you owe an additional $4,400 on your 2006 tax return. To find out if you owe a penalty, see if you meet the first safe harbor exception. Since 90% of $10,000 is $9,000, your prepayments fell short of the mark. You can't avoid the penalty under this exception.

However, in the above example, the safe harbor may still apply. Assume your 2005 tax was $5,000. Since you prepaid $5,800, which is greater than the 110% of the prior year's tax (110% = $5,500), you qualify for this safe harbor and can escape the penalty.

This example underscores the importance of making sure your prepayments are adequate, especially if you have a large increase in income. This is common when there is a large gain from the sale of stocks, sale of property, when large bonuses are paid, when a taxpayer retires, etc. If you need assistance in adjusting your withholding and/or estimated tax payments, please give us a call.

When notifying your relatives, friends and business associates of an address change, don’t forget to include the IRS. Why should you worry about the IRS when the last thing anyone wants is to receive a letter from them? The primary reason is that the IRS meets their notification responsibilities by sending notices and refunds to you at your “last known address.” You cannot claim that you did not receive the correspondence if they were never notified of your address change.

Not acting on certain IRS notices can have serious consequences. Although we dread receiving notices, it is better to quickly address and resolve any and all issues that involve the IRS. Delays only lead to more intense enforcement actions by the IRS, which becomes increasingly more difficult to resolve as time passes by. If it goes far enough, you could even lose some of your rights.

Don’t count on the Post Office to forward these notices to you. Make sure that the IRS and any state or local governmental agency you file returns with are notified of your address change using an IRS Form 8822. If you have others in you family, including children who are also filing returns, be sure to make out a Form 8822 for each one.

Please call this office with your change of address so we may update our records as well and provide assistance if needed.

The IRS has certified several vehicles under the new energy tax credit effective for 2006. This credit replaces the $2,000 tax deduction which was previously available to taxpayers who purchased new certified hybrid vehicles before the end of 2005.

The new alternative motor vehicle income tax credit is available for qualified fuel cell motor vehicles, advanced lean-burn technology motor vehicles, qualified hybrid motor vehicles and qualified alternative fuel motor vehicles purchased after 2005. For qualified hybrid vehicles, this credit is currently set to expire at the end of 2009.

The credit is determined differently for each type of vehicle and will not be the same for every vehicle and may vary considerably. For hybrid vehicles, it is based on a combination increased fuel economy and lifetime fuel savings and can be as much as $3,400. A motor vehicle doesn't have to be used in a trade or business or for the production of income in order to qualify for this credit, but it must be new.

• 2006 Ford Escape Hybrid Front WD - $2,600
• 2006 Ford Escape Hybrid 4 WD - $1,950
• 2006 Mercury Mariner Hybrid 4 WD - $1,950
• 2005 Toyota Prius - $3,150
• 2006 Toyota Prius - $3,150
• 2006 Toyota Highlander 4WD Hybrid - $2,600
• 2006 Toyota Highlander 2WD Hybrid - $2,600

Taxpayers who want the maximum available credit may want to consider buying early since the full credit is only available for a limited time. The full credit is only available up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th vehicle. After that, only 50% of the credit is allowed for the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, 25% in the fourth and fifth calendar quarters, and none after the fifth quarter.

Taxpayers, who are affected by the Alternative Minimum Tax (AMT), should be cautious in that the credit will only offset regular income tax and not the AMT, thus limiting or eliminating the credit for those taxpayers.

Taxpayers using the vehicles for business will be required to reduce the depreciable basis of the vehicle by the amount of the credit allowed. In addition, no credit is allowed for the cost of the vehicle taken as a Sec. 179 expense deduction.

It may be appropriate to call this office in advance to determine what tax benefit the purchase will provide..

Congress has imposed some tough new rules that will substantially limit the deduction for this popular charitable donation. Prior to this change, taxpayers were generally allowed to deduct the fair market value (FMV) of the vehicle.

It is common practice for charities to immediately resell the donated vehicles to a wholesaler at substantially reduced prices, generally far less than the FMV claimed as a deduction by the donating taxpayer. Under the law changes taking effect in 2005, if the deduction exceeds $500, the deduction will be limited to the gross proceeds from the charity’s sale of the vehicle.

Example: A taxpayer donates a car with a FMV of $2,000 to a charity. The charity immediately sells the car to a wholesaler for $900. The taxpayer would only be able to deduct the gross proceeds from the charity’s sale. This limits the taxpayer’s charitable contribution deduction to $900.

In addition, a written acknowledgement from the charity is required and must contain the name of the donor, donor’s tax ID number, and the vehicle identification number (or similar number) of the vehicle. The IRS has developed new Form 1098-C to incorporate all of the required acknowledgement elements for the donee (charitable organization) to complete. The donor is required to attach copy B of the 1098-C to his or her federal tax return when claiming a deduction for contribution of a motor vehicle, boat, or airplane.

There is an exception to the new rules for donated vehicles which the charity retains for their own use “to substantially further the organization's regularly conducted activities” or sells it at a price significantly below FMV (or gives it away) to a needy individual. This is in direct furtherance of the charitable purpose of a donee of relieving the poor and distressed or the underprivileged in need of a means of transportation. Please call this office for more information on these exception..

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The IRS recently provided additional guidance on some aspects of the production activities deduction. Under this provision, taxpayers are allowed a deduction equal to a percentage (3% for 2006; 6% through 2009; and 9% thereafter) of the lesser of their qualified production activities income for the tax year (i.e., net income from U.S. manufacturing, production, or extraction activities) or their taxable income, subject to a 50% of W-2-wages limitation. The guidance also provides liberalized rules for computing qualified production activities income.

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In a private letter ruling, the IRS recently ruled that the cost of removing mold from a rental property, or a property used in the course of a taxpayer’s business, would be currently deductible. This has been a question for some time, since the removal of asbestos from a building is a capital expense and not currently deductible.