Increase to Standard Mileage Rate
Beginning September 1, 2005 and running to the end of the year, the optional standard mileage rate for business miles increases 8¢ to 48.5¢. The rate also increased for deductible medical and moving expenses, increasing 7¢ to 22¢ a mile. These rates are in effect until the end of 2005, when a new rate will be provided by the IRS for 2006.
Tax Beat Goes High Tech Previous issues of Tax Beat are archived on our website at www.komisarbrady.com.
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The New Energy Tax Incentives Act Recently, the Energy Tax Incentives Act of 2005 was enacted. Even though the biggest chunk of the law is focused on such things as clean burning coal plants and oil and gas exploration, parts of the law will affect individual and small business taxpayers. Starting in January of 2006, tax credits potentially worth thousands of dollars will be available to those who purchase hybrid or diesel automobiles, make energy efficient home improvements, or install solar power equipment. These tax credits reduce your tax bill dollar for dollar, and are available whether or not you itemize your deductions.
If you are in the market for a hybrid or clean diesel vehicle, by waiting until 2006, you may qualify for tax credits to offset some of the cost. But do not wait too long, as the credits will be phased out after the auto maker sells 60,000 eligible vehicles. This phase-out is per automaker, not per model, and some hybrid models already have waiting lists. So, if you want to take advantage of these credits on some of the current popular models, you will need to act soon. The tax credit is made up of two parts - a vehicle fuel economy credit worth between $400 and $2,400 based upon the fuel-economy rating compared with vehicles in its same weight class, and a vehicle conservation credit worth between $250 and $1,000 based upon the estimated gallons of gas saved over the vehicle's lifetime. The calculation of the credit is complex, and as of now no one knows yet what each model's exact credit will be, but auto makers will surely promote the savings to expect at tax time. There are also credits for fuel -cell passenger vehicles, vehicles powered by compressed or liquefied alternative fuels, and an extension of the electronic car credit, but these credits probably will not affect most taxpayers.
In 2006 and 2007, you will be allowed a tax credit for making some energy-saving improvements to your home, such as replacing your current air conditioner, water heater, or furnace with a new highly efficient one, or installing energy-efficient windows, doors, or insulation. The credit is worth 10% of the cost of buying and installing these improvements, and is capped at a $500 maximum. There are rules about how much of a credit various improvements will be worth. The maximum credit for energy-efficient windows is $200, a $300 maximum credit for air conditioners, heat pumps or water heaters, up to $150 for a furnace or boiler, and up to $50 for an advanced main air circulating fan. The $500 is the total credit allowed over the two-year period. While the tax incentives to purchase energy-saving products are not as great as some other credits, the real savings are likely to come from lower home energy costs. Businesses can also take advantage of energy efficient improvements. If you own a commercial building, the new law offers you an "energy deduction" versus depreciation expense for improving your building's energy consumption. The maximum deduction is $1.80 per square foot of the building.
If you have ever thought of trying solar energy, this might be time to make the leap. The energy bill has increased the tax credit for commercial solar installations and now offers individual homeowners a credit for the cost of purchase and installation of solar equipment during 2006 and 2007. Businesses that buy solar equipment can claim a federal tax credit equal to 30% of the equipments cost (increased from 10%), with no limit on the amount of the credit. The increased credit applies to: (1) equipment which uses solar energy to generate electricity, to heat or cool (or provide hot water for use in) a structure, or to provide solar process heat; and, (2) equipment which uses solar energy to illuminate the inside of a structure using fiber-optic distributed sunlight. Homeowners get a more limited credit. A credit of 30% of the cost of purchase and labor of installation of a solar hot water system (for hot water heaters, radiant floors, or radiators), or a photovoltaic system (roof panels that take in energy from the sun and turn it into electricity) is available in 2006 and 2007. The maximum amount of the credit is $2,000 per system. An additional 30% credit can be taken on a fuel-cell heat and power system, up to $500 per 0.5 kilowatt of capacity. There are a couple of catches: The heating system cannot be for a pool or hot tub, and the federal credit applies to the net system cost after any state incentives.
This is just a summary of parts of the new law that can affect you. As you know, no tax law is as simple as this summary. There are many complex rules to qualify for these credits, and lots of the details have yet to even be decided. If you have any specific questions on how these credits might apply to you, please give us a call.
Business Succession Planning
By Jenni Bieck
Even though a business succession plan may be the most important component of a retirement and estate plan, far too many business owners do not have one. Although avoiding the issue is sometimes more comfortable than facing it and starting to plan makes you contemplate your own mortality, not having an effective succession plan can result in dire consequences. Without a plan, your death or long-term disability could mean the end of the business you worked so hard to build. Without an implemented plan, in retirement the value of your largest personal asset could rapidly decrease in value. With these consequences in mind, all business owners should develop a plan to transfer the business to the right people, under the right terms, at the right time, and for the right price.
A good business succession plan must begin with determining the goal of the succession plan. These goals will, in turn, determine who should be involved in the planning process, the vehicles and timeline used to accomplish the goals. All business plans are different based upon the goals of the owner, but certain issues are common to all succession plans.
Control
Determining who will be appropriate the future owner. By gradually relinquishing control, it will avoid confusion among employees and customers. If the retiring owner continues to work after ownership is relinquished, it is important to determine what to expect from the “retiring” owner’s work.
Management
An effective management team will provide assurance of your business’ continuity for your employees and customers, as well as for yourself. It is important that your management team can work well with any future owner(s), and this should be considered when you develop your succession plan to meet the goals you establish for the plan.
Valuation
While business owners may have a rough idea of the value of their businesses, they should consider hiring a qualified appraiser to determine this value at the inception of implementation of your business succession plan. This valuation will be helpful in the estate and gift planning process as well.
Funding
If a buy-sell agreement is implemented, the agreement should be funded to the fullest extent possible. Commonly, insurance policies are used as a means of funding purchases triggered by death or disability. The valuation will determine the amount and type of insurance required.
Communication
It is important to communicate your succession plan with all affected parties from the planning process through the implementation of the plan. Meet with key family members and management to review and provide feedback on the goals and the plan documents for the succession plan. Consult with accountants, attorneys, insurance agents, and management consultants to guide you with your plan and any transition phases needed to implement the plan. Communication to all interested parties will create a sense of security of your business’ continuity.
There is no easy way to create a business succession plan. All plans should be customized to your business and goals. They should be focused on the future strategy and culture of your business as well. It takes time to develop a plan, including transition phases and implementation, to protect what is often your largest personal asset. If you have no business succession plan, circumstances have changed in your personal or business life, or you think your current plan could stand a review to determine if you are meeting your goals, please give us a call. The sooner you begin developing a formal agreement, the better the chances are to implement the plan as you desire. It is very difficult, as well as stressful, to implement a long-term plan into a much shorter period of time.
HOME OFFICE DEDUCTIONS By Jenni Bieck
As more people venture out and start their own businesses and more employees telecommute to work from home, many more people are able to claim a home office tax deduction. This article examines the requirements, benefits and adverse effects of the home office deduction.
Allowable deductions The home office deduction allows you to deduct housing related expenses which would otherwise be nondeductible. Expenses incurred for insurance, maintenance, utilities, and depreciation of your personal residence are examples of deductible expenses. You can also deduct real estate taxes and mortgage interest relating to your home to offset business income as part of the home office deduction. The home office deduction is subject to the business use percentage of your home which can be determined by any reasonable method. One common method is to divide the area used for business by the total area of your home. Deductions are also limited to your business net income.
A taxpayer will qualify for a home office deduction if their home office is used exclusively and regularly as the principal place of business for any trade or business. Heavy emphasis is placed on the “exclusive-use” rule. If the business part of your home is used at all on a personal level, the deduction is disallowed. Besides being used exclusively and regularly as the principal place of business, a home office deduction is also allowed if the use of your home is a place where patients, clients, or customers regularly meet in the normal course of business. If a separate structure of your home is used, such as a garage, it must be used exclusively and regularly for your business. It does not have to be your principal place of business or a place where you meet with patients, clients, or customers. An employee is also eligible for a home office deduction, but must meet all of the requirements as a self-employed person plus establishing that home office use is for the convenience of the employer.
Exceptions to the exclusivity rule are granted for qualified daycare providers and for the storage of inventory or product samples in your home. This means that areas designated for daycare and areas for storage can also be used for personal uses (In order to qualify for the daycare exclusion you must be a licensed daycare or be exempt in needing a license).
Although “trade or business” is not clearly defined, the trade or business must be undertaken with a profit motive, and must be regular and continuous. If you use your home for a profit-seeking activity, but it is not your trade or business, you do not qualify for the deduction. For example, if an investor manages his own portfolio at home to gain capital appreciation, that is not considered a trade or business. However, a “trader” who works 40 hours a week with the goal of making a gain on short-term sales would qualify.
Your home must be the principal place of your business to qualify for the deduction. If you have more than one fixed location for your business, you must consider the relative importance of the activities performed and the amount of time spent at each place to establish whether your home qualifies as a principal place of business. Fixed locations are permanent offices or workplaces, such as a home office or employer-provided offices, but not hotel rooms or cars. Minimal administrative or management activities performed at a fixed location outside of your home will not disqualify you for the deduction.
If a taxpayer uses one home office for more than one trade or business, each activity must separately qualify for the deduction. If one activity does not qualify, none of the activities will. This all-ornothing test tends to disqualify full-time employed taxpayers with a side business where work for both is done in a home office. For example, a professor uses his home office in connection with the courses he is teaching. He also uses his home office to write a book. If the professor does not qualify for the deduction related to his teaching (perhaps because the school provides professors with an office at their facilities), he will not be able to claim any home office deduction, even if the activities for writing his book would qualify on their own.
How to deduct it
Self-employed taxpayers reporting business income and expenses on Form 1040 Schedule C will report their home office deduction on Form 8829 to reduce business income. The reduced business income will lower not only your taxable income, but also reduce the amount of self-employment tax. Employees claiming home office deductions must file Form 2106. Form 2106 will report the expenses as a miscellaneous itemized deduction (subject to 2% of adjusted gross income limitation) on Form 1040 Schedule A. This means that if an employee does not itemize his deductions, he will not be able to claim a home office deduction.
To calculate how much of your otherwise nondeductible expenses (adjusted for business use) can be deducted, your business must be operating at a profit. From business net income, subtract the business portion of normally deductible expenses such as real estate taxes and mortgage interest. The expenses not deducted here may be taken as an itemized deduction (where it normally is deductible). If your business still has income, the business portion of normally nondeductible expenses can be subtracted to the extent of income. Depreciation is the last expense allowed to be subtracted to the extent of any remaining income. Any expense not allowed to be taken because it would result in a business loss can be carried forward to future years.
Adverse effects The home office deduction is designed to benefit taxpayers working at home, but is it beneficial to take the deduction? The greater your business use percentage is and the greater your otherwise nondeductible expenses are, the more beneficial the deduction may be for you. Employees are limited to how much they can deduct because the deduction is limited to 2% of adjusted gross income. If the benefits of this deduction will exceed its costs, it may be advantageous to take the deduction.
Home-based business scams and tax avoidance promotions have gained popularity over the last few years, raising a red flag to the IRS. This means that the chances of being audited are greater when claiming a home office deduction. Taxpayers also carry the burden of proof, which means it is important to keep complete and accurate documentation of any expenses you choose to deduct. Documentation should also include the reasonable calculation of a business use percentage.
When you sell your personal residence, a home office deduction claimed in previous years may lead to adverse effects. The general rule regarding the sale of your personal residence is that you may exclude up to $250,000 (or $500,000 for married filing joint taxpayers) of gain realized on the sale of your home, if you meet the qualifications. However, when you use a portion of your personal residence for business purposes, you must reduce the basis of the residence by the amount of depreciation allowed or allowable, and you cannot exclude the portion of the gain created by the depreciation. That gain attributable to the recapture of depreciation will generally be taxed at 25%. The law is written so that you reduce the basis of your personal residence by the amount of depreciation allowed or allowable, meaning that you cannot take other parts of the home office deduction and pass on taking depreciation expense to avoid the depreciation recapture gain on the sale of your personal residence. The basis of your house is reduced whether or not depreciation is taken as part of the home office deduction. The full exclusion on the sale of the personal residence is still available on the nonbusiness use portion of the personal residence, assuming you qualify.
A home office deduction can be very beneficial, especially if you are self employed. The deduction not only reduces income tax relating to your business, but also the self-employment tax assessed on your income as well. There are strict qualifications, more extensive record-keeping requirements, and your return will be more likely to be audited. The increased risk of audit should not deter you as long as you meet all the qualifications, and keep adequate records; you are entitled to the deduction. If you would like more information, or an analysis of whether or not you qualify and the potential benefit of the deduction, please give us a call.
USE OF FAMILY LIMITED PARTNERSHIPS How do you stay in control of your assets, make gifts to your family, and lower income and estate taxes? A family limited partnership (FLP) is a very popular tool in estate and income tax planning that helps protect, leverage, and control family wealth. Here's how it works and what it can do for you.
A family limited partnership is a standard limited partnership which has various family members as partners. There are two types of partners in an FLP - general partners and limited partners. A general partner has control, management responsibility and unlimited liability in connection with the partnership assets. A limited partner is a passive investor with no management rights or responsibilities. Typically, senior family members transfer property into the partnership in exchange for a small general partnership interest and a very large limited partnership interest. The senior family members then gift units of their limited partnership interest to junior family members. The senior family members, even though their total ownership percentage decreases, still remain in complete control over all investment and management decisions relating to the all the underlying partnership property because they still hold 100% of the general partnership interest.
One of the primary benefits of the FLP is its ability to maximize annual tax-free gifts to family members. Under the present law, an individual may transfer $11,000 ($22,000 for married couples) tax free to any person each year. This gift reduces that estate, but causes a loss of control over assets. The limited partnership allows you to make annual gifts of limited partnership interests to the other partners without giving up any control (in order to ensure that the gifted partnership units will not be included in the estate of the senior family members/donors, the partnership agreement needs to be carefully drafted with specific language included in the agreement). Gifts are made simply by transferring a partnership interest to another partner. Since only a limited partnership interest is being transferred and not the asset itself, you will still stay in control as the general partner. Because of the management authority restrictions and generally a lack of marketability, the limited partnership interest has a reduced value compared with the underlying asset. This allows you to effectively make larger annual tax free gifts. For example, if for gift tax purposes a 40% discount is allowed for the limited partnership interests, you could transfer a limited partnership interest representing up to $18,300 without exceeding your annual gift tax exclusion of $11,000 per donee ($18,300 x 60% = $11,000).
Family limited partnerships provide very good creditor protection. The general partner of a limited partnership bears total personal liability for debts of the FLP. While creditors can reach the personal assets of the general partner, a limited partner bears no liability for debts of the FLP beyond the limited partner's interest in the partnership. Through additional planning techniques, the general partner's liability can be further limited.
Another advantage of creating an FLP is the shifting of your income tax burden to other family members. Income of the partnership is passed through to the partners whether full distributions of income are or are not made. This can allow for an overall family income tax reduction because the tax will be paid at each partner's tax bracket, rather that yours, which may be substantially higher. Your children and grandchildren may participate in the growth of all assets in the partnership at income tax rates, typically lower than yours.
An FLP provides much flexibility in estate planning as well as business operations. Compared to an irrevocable trust, which may not be amended, the partnership agreement may be amended or terminated at any time. The FLP does have drawbacks though. The most substantial being the cost, both the initial cost of setting up and transferring the assets to the partnership, but also the ongoing cost of accounting for the activity of the partnership, the cost of preparing a yearly tax return, and legal and appraisal costs relating to gifts of partnership interests, changes to the partnership agreement, and other matters. Even with these additional costs, in many circumstances a properly created and planned FLP can benefit you and your family. If you believe that a family limited partnership could be part of your estate or income tax plan, please let us know, and we can discuss further in depth the advantages and disadvantages as it relates to you your particular situation.
What Some Retirement Contributions Are Worth By Stephen Bjork
As great uncertainty still exists with social security, it is becoming obvious that a plan for retirement needs to rely less on social security income and more on retirement savings. With that being said, here are few examples of ways to increase your retirement savings and what these savings could be worth.
Catch up contributions for those over age 50 Back in 2001, the tax law was changed to allow individuals age 50 and over to make additional "catch-up" contributions above and beyond the "regular" contribution limits to their 401(k), 403(b), IRA's, Roth IRA's and other retirement accounts. The size of these catch-up contributions has increased since 2001, from a $1,000 401(k) catch-up contribution in 2002 to $4,000 in 2005 and $5,000 in 2006 and beyond. These catch-up contributions can significantly increase your retirement savings. For example, assume you turn 50 during 2005 and make the maximum catch-up contribution for this year and the following 15 years up to age 65. At the end of those 16 years, assuming an 8% rate of return, those catch-up contributions would be worth $149,465. Since you are not required to take a retirement contribution until age 70, the value of those catch-up contributions can grow to be much greater.
Taking advantage of employer match If an employer matches a part of your retirement plan contributions, please take advantage of it and encourage others to do the same. Even though you might have other expenses and retirement is a long way off, do not pass up free money. To illustrate how much free money you may have, according to surveys, the average employer match per US worker is $985. Earning 8% per year, that $985 deposited annually over your 40 year of employment would be worth over $275,500.
Making IRA contributions as a teenager Anybody, even teenagers who have earned income can contribute money to an IRA or Roth IRA account, as long as their total income does not exceed the contribution limitation. If your teenager, even if assisted by you partially or fully saves for retirement now, those contributions can be worth hundreds of thousands of dollars when she retires. If, for example your teenager contributes $2,000 per year beginning at age 16 for 4 years and assuming an 8% rate of return, that $8,000 in contributions will be worth approximately $384,000 when she turns 65. Using a Roth IRA account, that money will be withdrawn tax free. And since it is more than likely that your teenager's income will be taxed at the lowest rates, if at all, the non-deductible Roth IRA contribution will not increase their tax burden today, but could save them thousands in taxes when they retire.
All of these examples assume an annual 8% rate of return, and differences in the rate of return can greatly affect the value. Also remember, that unless a Roth IRA or Roth 401(k) is used, income tax will be owed on the retirement savings upon distribution, which will affect the after tax value of these amounts.
To ensure compliance with Treasury Circular 230, we are required to inform you that any advice concerning U.S. federal tax issues contained on this website is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code and was not written to support the promotion or marketing of any transaction or matter discussed herein. Application of tax regulations is specific to the individual or business and we recommend that you consult a qualified Komisar Brady tax professional for how the above information may apply to you.
