Financing is often an issue of concern when starting a new business or expanding an existing one. A good place to start is with the Small Business Administration (SBA). However, many entrepreneurs prefer to use the equity in their homes, which will probably provide a lower interest rate and a longer payback period.

If you are considering such a move, be aware that there are complications when you borrow against your home and use the funds for business. The interest paid on home mortgages that are secured by the taxpayer’s home is by definition home mortgage interest and, as such, can only be deducted as home mortgage interest. In addition, home mortgage interest cannot be allocated to other uses to the extent it is allowable, either as interest on acquisition debt or as the first $100,000 of equity debt interest. Excess debt interest (interest on debt that exceeds the deductible debt limits) can be allocated to other uses under the general tracing rules.

Why is that a problem? There are two reasons: (1) you can only deduct home mortgage interest if you itemize your deductions, so if you deduct the standard allowance, you receive no benefit for the business interest; and (2) interest deducted on your business schedule offsets both income and self-employment tax—not to mention other tax benefits if you are unfortunate enough to have a loss, but mortgage interest deducted on Schedule A is not allowed as a deduction in computing the self-employment tax.

What is the solution? If you have already exceeded your home mortgage debt limits, you can go ahead and take more equity out and allocate the interest to your business. If not, you can utilize the “unsecured election,” which allows taxpayers to treat the loan as unsecured, and then use the general tax tracing rules and allocate the business portion of the interest back to your business. There is one pitfall to this election.

If the loan is mixed-use (part home and part business), then the home portion of the interest can no longer be deducted as home mortgage interest, since by definition a home mortgage must be secured by the home. A solution to that would be to take a separate loan on the home for the business debt, even though the interest rate might be slightly higher.

If you are in need of business capital and are considering refinancing your home, please call our office for assistance. We will gladly address all of your concerns.

Congress has provided a variety of tax-favored retirement savings plans for taxpayers to use, and the amount that can be contributed to these savings plans is increasing each year. If you are age 50 and over, you are even allowed to make larger “catch-up” contributions.

IRA contributions may be limited by your adjusted gross income (AGI). Nondeductible contributions can be made to traditional IRA accounts without concerns about income limitations. Deductible traditional IRA contributions can also be made without any regard for income, provided the taxpayer or spouse is not an active participant in an employer-sponsored pension plan. If either spouse is an active participant in an employer’s plan, then the traditional IRA deductible amount is ratably phased out based on the AGI. The phase-out ranges are as follows:

Special rule for spouses who are active participants - For an individual who is not an active participant but whose spouse is, the traditional IRA is phased out for the non-active participant if the combined AGI is between $150,000 and $160,000.

For Roth IRAs, the income phase-out is not inflation-adjusted and ranges between $150,000 and $160,000 for joint filing taxpayers, $0 to $10,000 married separate taxpayers who live with their spouse and $95,000 to $110,000 for all others.

Beginning in 2006, assuming your employer’s 401(k) permits, you can designate the 401(k) plan contributions to be “Qualified Roth” contributions. Like a Roth IRA, there is no tax benefit at the time of the contribution, but all distributions when you retire, including earnings, will be tax-free.

If you have questions regarding any of these plans, we encourage you to call.

In their earlier stages of life, individuals purchase life insurance to provide security for their family. But after the children have left the nest and the insured individual has entered his or her golden years, the original need for the insurance may have changed. If the individual is single, there may be no need for the insurance at all. For financially strapped elderly individuals, the insurance policy may represent a source of badly-needed cash.

Generally, life insurance proceeds received under an insurance contract as a result of the insured's death is tax-free. However, if the contract is sold while the insured is still living, the proceeds in excess of the cost of the contract are taxable in the year received.

Viatical Settlement Exception – In a situation where the individual is either terminally or chronically ill and death benefits are assigned to a viatical settlement provider (one that regularly buys or takes assignments of life insurance contracts and meets the required standards), the proceeds would not be taxable. (Code Sec. 101(g)(2)(A))

• Terminally Ill - A person is considered terminally ill if he or she has been certified by a physician as having an illness or physical condition that can reasonably be expected to result in death within 24 months of the date of certification. (Code Sec. 101(g)(4)(A))

• Chronically Ill - A person is considered chronically ill if he or she has been certified within the previous 12 months by a licensed healthcare practitioner as (Code Sec. 101(a)(2)(A)):
(1) Being unable to perform without substantial assistance at least two activities of daily living (e.g., eating, toileting) for at least 90 days due to a loss of functional capacity,
(2) Having a similar level of disability as determined by the IRS in consultation with the Dept. of Health and Human Services, or
(3) Requiring substantial supervision to protect him or herself from threats to health and safety due to severe cognitive impairment.

The term “chronically ill individual” does not include a terminally ill individual.

Thus, if there is no overriding reason to retain the insurance, it can be used to provide financially strapped seniors or individuals with a life-threatening illness, such as cancer, AIDS, heart disease, Alzheimers, or multiple sclerosis with a source of cash to meet their needs.

Even if the individual does not qualify for a viatical settlement, it can still provide a source of revenue that is only partially taxable, and with careful planning, the tax liability can be minimized.

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The Internal Revenue Service has issued a notice on how commercial building owners or leaseholders can qualify for the tax deduction for making their building energy efficient. The notice establishes a process to certify the required energy savings in order to claim the deduction.

The commercial building deduction, which was enacted in the Energy Policy Act of 2005, allows taxpayers to deduct the cost of energy-efficient property installed in commercial buildings. The amount deductible may be as much as $1.80 per square foot of building floor area for buildings that achieve a 50-percent energy savings target. The notice provides that buildings below the 50-percent threshold may, nevertheless, qualify for a deduction of up to 60 cents per square foot of building floor area if they meet a 16-percent energy savings target.

Before claiming the deduction, the taxpayer must obtain a certification that the required energy savings will be achieved. Today's notice prescribes the content of that certification and the qualifications that must be met by the person providing the certification.

The notice also announces that the Department of Energy will create and maintain a public list of software that must be used to calculate energy savings for purposes of providing the certification. It also provides a process that software developers must use if they desire to have their software included on that list.

For more information see Notice 2006-52 which can be found at www.irs.gov.

Hoping to encourage higher savings and more banking, the IRS announced that it will create a new program to allow taxpayers who use direct deposit to divide their refunds in up to three financial accounts.

The IRS will create a new form, Form 8888, which will give taxpayers greater control over their refunds. Form 8888 will give taxpayers a choice of selecting one, two or three accounts such as a checking, savings or retirement account. Taxpayers who want their entire refund deposited directly into one account can still use the appropriate line on the Form 1040 series.

Exact details of the split-refund program, including a draft of Form 8888, are still being decided. The IRS intends to meet with a number of consumers, tax professionals and software associations to seek suggestions on operational and promotional details. The program will take effect in January 2007.

More than three-quarters of the nation’s taxpayers received refunds each year. Last year, the average refund was $2,171. The IRS repeatedly has encouraged taxpayers to adjust their payroll withholding to ensure they pay only the taxes required, but some people appear to view payroll withholding as a way to save money.

Direct deposit of refunds was first offered in 1987. Last year, the IRS issued 100 million refunds (from 133 million tax returns) amounting to $217.6 billion. Of those figures, 52.7 million refunds amounting to $134.2 billion were deposited directly into bank accounts.

Currently, taxpayers have two options for receiving their individual federal income tax refunds – a paper check or a direct deposit (electronic funds transfer) into a checking or savings account. The electronic funds transfer gives taxpayers the safety and speed of direct deposit. Taxpayers who file their tax return electronically and opt for direct deposit can receive their refund in two weeks or less.

The split-refund program will allow taxpayers to conveniently designate – at the time they file – and deposit their refunds with any U.S. financial institution as long as they provide valid routing and account numbers. Taxpayers will attach a new Form 8888 to their returns indicating amounts for each allocation and providing account information.

This ability to split or allocate their direct deposit refunds among multiple accounts will be available to all individual filers, whether they file Forms 1040, 1040A/EZ, 1040NR or any of the other 1040 series forms.

October 16 is the FINAL extended filing due date for your 2005 individual income tax return. Generally, this filing date is October 15, but when the due date falls on a Saturday, Sunday or holiday, it is not due until the next business day.

October 15 may still be a month and a half away, but it is best to file as soon as possible to minimize late payment penalties on any tax that might be due. In addition, filing early eliminates all the last minute stress of getting the return completed and filed before the due date. Generally, this office needs the materials to complete the return no later than October 8 to have it prepared in time.

If you are having difficulty obtaining the materials to complete your return by the due date, please call this office as soon as possible to discuss the situation and any possible alternatives that might be available.

There are no additional extensions available after this due date. Extension returns filed after October 16 will be subject to the late filing penalty of 5% per month or any part thereof of the tax due on the return for a maximum penalty of 25% of the tax due. Returns with no tax due or one receiving a refund will not be subject to this penalty for federal filing purposes.

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 may vary considerably. For hybrid vehicles, it is based on a combination of increased fuel economy and lifetime fuel savings and can be as much as $3,400. Therefore, the higher the credit, the more fuel-efficient a vehicle will be.

A motor vehicle does not 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.

Taxpayers who want the maximum available credit may want to consider buying early since the full credit is only available for a limited time (explanation below about the 60,000 manufacturer limit).

Taxpayers who are affected by the Alternative Minimum Tax (AMT) should be cautious in that the credit will only offset the 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.

Standard Mileage Tax Strategy – With gas prices going through the roof, taxpayers might consider taking advantage of the energy tax incentives available for the purchase of hybrid vehicles. If a taxpayer uses a vehicle for business, they can choose between deducting actual expenses such as fuel, repairs, insurance, etc., or deducting a standard amount for each business mile driven. The standard mileage rate is determined periodically by the IRS using average costs of operating a vehicle. By using the standard mileage rate with a high fuel-efficient vehicle, it is conceivable that a taxpayer’s deductions could be more than the actual cost of operating the vehicle.

If you are planning a hybrid vehicle purchase, it may be appropriate to call this office in advance to determine what tax benefit the purchase will provide.

Certified Vehicles (at press time) – The IRS has acknowledged the certification of the following vehicles for the hybrid and alternative fuel tax credit.

60,000 Vehicle Limit - Taxpayers may claim the full amount of the allowable credit for qualified hybrid motor vehicles up to the end of the first calendar quarter after the quarter in which the manufacturer records its sale of the 60,000th vehicle. For the second and third calendar quarters after the quarter in which the 60,000th vehicle is sold, taxpayers may claim 50% of the credit. For the fourth and fifth calendar quarters, taxpayers may claim 25% of the credit. No credit is allowed after the fifth quarter.

Vehicle Limit Applies to Manufacturer – Vehicle Models - The 60,000 hybrid vehicle limitation applies to the total of all qualified hybrid models sold by a manufacturer, not to each qualified hybrid model sold by it. Once the threshold is reached and the credit either is reduced or is eliminated for vehicles sold by a particular manufacturer, a prospective purchaser may want to factor the reduced or eliminated tax break into his choice of which vehicle to purchase.

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For years, the IRS has been tracking taxable interest to make sure taxpayers report it on their returns by requiring payees to issue 1099s. However, tax-exempt interest, such as interest from municipal bonds, has never been included in the 1099 reporting requirement. This changes beginning with the 2006 tax year. Payers will now be required to report to the IRS tax-exempt interest that they paid to others.

Why did Congress add this requirement in the new tax law? Although the tax-exempt interest is not subject to federal income tax, it is included in the computation of taxable Social Security benefits and the Alternative Minimum Tax (AMT). This new reporting requirement will prevent taxpayers from being able to omit tax-exempt income from their returns and avoid additional taxes on their Social Security income and/or increased AMT.

The Tax Court has ruled that a taxpayer's mortgage payments on a home solely owned and occupied by him couldn't be deducted as alimony. Although the divorce degree obligated him to make mortgage payments to shield his ex-wife from liability, the payments didn't confer a direct economic benefit on her. (Picou, TC Summary Opinion 2006-82)

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Per Diem Rates (for travel within the continental United States) has been revised to reflect maximum per diem rate changes for certain locations in the following states—California, Georgia, Illinois, New York, North Carolina, Ohio, South Carolina and Washington. See IRS Publication 1542.

The publication is for employers who pay a per diem allowance to employees for business travel away from home within the continental U.S., on or after
October 1, 2004, and before January 1, 2007. It gives the maximum per diem rate that can be used without treating part of the per diem allowance as wages for tax purposes. The new rates appear in Table 4 of the publication.