Tax Tips

Don't rely on estimates.
Don't pay for expenses with cash.
Set up a reliable bookkeeping structure.
Maintain a separate bank account for the business.
Don't ever make a business decision exclusively because of the tax benefits.
 
 

Don't rely on estimates.  Keep track of anything that might be a business related expense.  At tax time you won't be able to rely on your memory, and the IRS is not in a position to take estimates.

Don't pay for expenses with cash.  In order to deduct expenses at tax time, you need a record.  A check number or a credit card bill can serve as documentation.  Save both the canceled checks and paid invoices.  I have represented taxpayers in audits where the revenue agent demanded both.

Set up a reliable bookkeeping structure. You need to know how  well you're doing.  If you've made sales but haven't collected the money, your monthly records will give you an accurate account of your business' earnings.

Maintain a separate bank account for the business.  The IRS is becoming more meticulous about examining home-based business filings, since some hobbyists will attempt to file a Schedule C to deduct expenses related to their hobby.  Keeping careful records and maintaining a separate bank account for business expenses will help you prove that your business is a legitimate, money-making venture.

Don't ever make a business decision exclusively because of the tax benefits.  Your business isn't about saving taxes.  Instead, you need to focus on how you're going to make money.  Worry about taxes after the profits come.

 Capital Gains
 Sale of Principal Residence
 Home Office Deduction
 HOPE Scholarship credit and lifetime earning credit
 Net Operating Loss carryback and carryover
 Self Employed Health Insurance

 Deduction for Charitable Mileage
 Education IRA's
 Interest on Education Loans
 Roth IRA's (New)
 Increase in Estate and Gift Tax Credit
 General Business Credit Carryback
 Penalty for Underpayment of Estimated Tax
 Modification of Safe Harbor Estimated Taxes

 Section 179 Write-off of Business Assets
 Business Travel and Per Diem
 Business Auto Mileage
 How to compile your tax data
 California Family Limited Partnership

Sale of Personal Residence -   Under the new law, a single person can exclude up to $250,000 of gain and a married couple who file a joint return can exclude $500,000 of gain.  In order to exclude $500,000, married taxpayers must meet all of the following conditions:

•   A husband and wife must file a joint return for the taxable year in which the property is sold or exchanged;
•   One spouse must meet the ownership test for the property;
•   Both spouses must meet the use test for the property;
•   Neither spouse has used the new exclusion during the two year period ending on the date of the sale or exchange.

These old rules no longer apply:

•   The over age 55 rule;
•   Reinvesting proceeds in a new principle residence;
•   Deducting fixing up expenses;
•   Only one exclusion during a taxpayer's life;
•   Deferral of gain.  You may not defer gain under the new law.  If the gain exceeds the $250,000/$500,000 amount, it is taxed in the year of sale.

For 1998 an extremely important clarification was made - if you fail to meet the full two year requirement (due to change of employment, health or other unforeseen circumstances), you may utilize a fraction of the exclusion.  As an example: A first time homeowner who is a single taxpayer owns and uses a property as his principal residence for a period of 18 months.  He must sell the home during 1998 because of a job change, and makes a $50,000 profit on the sale.  Under the revised partial exclulsion rule, he can exclude his full $50,000 profit.
Depreciation Recapture - Depreciation claimed after May 6, 1997 is recaptured and taxed at 25%.  This would occur, for example, if you had used a portion of your residence for business purposes.

Transition Rules - For sales before May 7, 1997, prior law (two year rollover, over age 55 and so forth) applies.  For sales from May 7, 1997 to August 5, 1997, you can elect to use either the old law or the new law.  For sales after August 5, 1997, the new law applies with limited exceptions.

Capital Gains - This long awaited provision finally passed.  Several compromises had to be accepted to make it work but, for the most part, relief was granted on capital gains.  Here are the basics:

The magic date is May 6, 1997.  For sales of long term capital assets after that date, the maximum capital gains rate is 20% (10% for individuals in the 15% tax bracket).  For an asset to be classified as long term it must have been held for longer than one year if it was sold before July 29, 1997 and longer than 18 months if sold after July 28, 1997.  Please note that the new rates and holding periods apply to installment sales that originated in earlier tax years.  In order to properly prepare your taxes for 1997 I will need to know the dates that installment payments were received.

Home Office deduction - The definition of a taxpayer's "principle place of business" has been expanded for purposes of claiming a home office expense deduction.  The office must be used to conduct business-related administrative or management activities and there can be no other fixed business location where such activities take place.

HOPE scholarship credit and lifetime learning credit - New tax credits may be elected by low and middle income individuals for tuition expenses incurred by students pursuing college or graduate degrees or vocational training.  The HOPE scholarship credit provides a maximum allowable credit of $1,500 per student for the first two years of post-secondary education, and the "lifetime learning credit" allows a credit of 20% of qualified tuition expenses for any year the HOPE credit is not claimed.  These credits phase out, generally, when income levels reach $40,000 for individuals and $80,000 for joint filers.

Net Operating Loss carryback and carryover - The net operating loss carryback period has been shortened from three to two years, while the NOL carryforward period has been lengthened from 15 to 20 years.  The three year carryback period is retained for certain casualty, theft and disaster losses.  The applicable date for this provision is August 5, 1997.  Carryover losses from earlier years are not affected.

Self Employed Health Insurance - Self employed individuals may deduct from gross income 40% of amounts paid during 1997 for health insurance for themselves, spouses and dependents.  This deduction is limited to the earned income from the taxpayer's trade or business.   California has conformed to this provision for 1997 only.  Legislation will be required to extend in the future.

Deduction for Charitable Mileage - The standard mileage rate used for computing the charitable use of an automobile has been increased to 14 cents per mile beginning in 1998.

Education IRA's - Beginning in 1998, taxpayers can open education IRA's for paying qualified higher education cost of designated trust beneficiaries under the age of 18.  There is an income limitation and the phaseout begins at $95,000 for singles and $150,000 for joint filers.  There are also many other restrictions and limitations.  If you are interested, contact me and we can discuss the possibilities.

Interest on Education Loans - A limited deduction is allowed for interest paid on qualified education loans.  This deduction is available to non-itemizers.  The maximum deduction for 1998 is $1,000.

Roth IRA's - Although contributions to the new, backloaded "Roth IRA" are nondeductible, the buildup of interest and dividends in the account may be tax-free depending on how and when the taxpayer makes withdrawals.  Eligibility to make contributions is limited by the taxpayer's income level.  Phaseout begins at $95,000 for singles and $150,000 for joint filers.  Unlike deductible IRA's, individuals are allowed to make contributions to a Roth IRA even after age 70 1/2.

Most mutual funds (Fidelity, T. Rowe Price, etc.) have Roth IRA tools available on the internet.  I have some software which is helpful in analyzing the pros and cons of converting existing IRA and starting new ones.  If you would like an analysis please come in (after tax season) and we can go over the different options available.  There are some changes being written in the upcoming Technical Corrections Act that will affect Roth IRA conversions.  For one thing, expect a requirement that Roth conversion IRA's be maintained in a separate account.  This seems prudent anyway but I expect that it will be a requirement (retroactive to January 1, 1998).

Increase in Estate and Gift Tax Credit - Through 1997 the unified credit amount is $192,800.  This effectively makes the first $600,000 of a taxpayer's estate exempt from estate and gift taxes.  This credit increases the exemption amount to $625,000 in 1998 and will be phased in as follows:

                                   1998       $625,000
                                   1999       $650,000
                                   2000       $675,000
                                   2002       $700,000
                                   2004       $850,000
                                   2005       $950,000
                                   2006     $1,000,000
 

General Business Credit - The carryback period for the general business credit has been reduced from three years to one year and the carryforward period has been increased from 15 years to 20 years for credits arising in tax years after 1997.

Penalty for Underpayment of Estimated Tax - The threshold for imposing underestimation penalties has been increased from $500 to $1,000.  Unless requested I generally recommend paying estimated taxes even though the threshold amount is not anticipated to be exceeded.

Estimated Safe Harbor Modified - In 1997, taxpayers with adjusted gross incomes exceeding $150,000 were allowed to make estimated payments of 110% of the prior year's tax and avoid penalties.  Under the new rules, if the preceding year begins in 1998, 1999 or 2000 the safe harbor is 90% of the tax or 105% of the prior year's tax.  In 2001 the safe harbor is 112% of the prior year's tax and in 2002 and after 110%.  For the 1998 tax year the requirement is 100% of the 1997 tax.  I truly do not know why or how these amounts were computed.  Unless you tell me otherwise, however, I will use these safe harbor guidelines to keep you safe from penalties.

Much more . . . The above items just scratch the surface.  I will try, via my Organizer, to steer you to the items that affect your individual situation.  More importantly, if you have any questions at all please bring them up, either at your tax interview, by telephone, by note or letter.  I will be happy to explore any avenue to insure that we arrive at the proper tax liability in your case.

Business Assets - Generally up to $18,000 in assets placed in service in a business in 1997 can be expensed under Code Section 179.  This provision does not apply to real property.  Use Form 4562 to expense assets under Section 179.  Do not make the mistake of merely expensing them.  This will result in a disallowance of the expense by the IRS.  Once the year is closed you do not have the option of electing to expense these assets and you will be limited to regular depreciation.

Business Travel - The per diem rates for travel can generally be used to substantiate properly documented business travel but not if you own 10% or more of the stock of the paying corporation.  In that case you must substantiate the expense with actual receipts (although reimbursement can be made at the standard per diem rate and will be excludable from income under an accountable reimbursement plan).

Business use of Auto - The standard mileage rate for the business use of an automobile in 1997 is 31.5 cents per mile.

How to compile your tax information - This is the method that I recommend to my tax clients:

Income:  Gather all your records of taxable income from savings bank books, deposits in checking accounts, stockbrokers' statements, real estate agents' statements, insurance company data, etc.  Income received but not deposited must also be reported.  Copies of your 1099 notices and W-2's should be brought to your conference or included in the data you drop off or mail.  My Tax Organizer is designed to help you remember which items to accumulate.  It is helpful if you list the amounts in the appropriate areas.

Expenses:  I suggest that you preliminarily review the list of deductions on the questionnaire.  Then, go through whatever payment records your have -- checkbook or checks, paid bills, receipts and other memos -- and sort them according to type of expense deduction.  Finally, list the details on the Organizer.

I have found that the best procedure for assembling data for tax deductions is:

    1.  Remove from each monthly bank statement the canceled checks representing tax deductions.

    2.  Go through bank statements for January and February 1998 to remove checks written in
         1997 that cleared in 1998.

    3.  Sort the checks in to groups -- charities, taxes, medical, etc.

    4.  Summarize data from canceled checks onto the questionnaire.

    5.  File the checks, by groups, in a large envelope labeled "1997 Tax Data".  These checks
         will be readily available in the event of a tax audit.

Organizer - If you are not a current tax client of our office call or e-mail us and we will be glad to provide you with one of our Organizers to help you get it together.  No obligation.

California Family Limited Partnership - This is a tool that is being used to transfer wealth to selected heirs.  The Family Limited Partnership (or Limited Liability Company) allows a taxpayer to transfer wealth to his family tax free (by annual gifting).  The value of the gift is reduced for tax purposes, allowing the taxpayer to give each donee about $15,000, yet claim that it is worth only $10,000 after IRS-allowed discounts.  Even after making the gift, the taxpayer retains control over the gifted assets.  Future earnings are taxed to the donee and future growth stays out of the donor's estate.