Tax and Business Alert - February 2004

Qualifying for Head of Household Status

Failure to use head of household (HOH) filing status is one of the most common tax filing mistakes cited by the IRS. HOH status is preferable to single or married filing separately status because the tax rate brackets are more favorable and the standard deduction is larger.

If you are not eligible to file jointly or as a qualified surviving spouse, HOH filing status is the best alternative to minimize your income tax liability. You may qualify to use HOH filing status if you provide support for your child, grandchild, sibling, or other relative. This includes paying more than half of the cost of maintaining a home for your dependent parent, including the cost of a rest home. Dependents other than parents must live in the same household with you for you to qualify for HOH status. The same person cannot be used to qualify more than one taxpayer for HOH status in the same year.

To qualify as a HOH, you must meet both of the following requirements:

1. Be unmarried (or considered unmarried for this purpose if married, but living apart during the last six months of the year) on the last day of the tax year.

2. Have paid more than half the cost of a maintaining a home that was the principal home for more than half the year of yourself and any of the following persons:
a. Your unmarried child, grandchild, stepchild, or adopted child regardless of
whether the child can be claimed as a dependent.
b. Your married child, grandchild, stepchild, or adopted child who can or could
be claimed as a dependent.
c. A foster child who can be claimed as a dependent.
d. A relative who can be claimed as a dependent.

The expenses of maintaining the home include such costs as rent, property taxes, insurance, mortgage interest payments, maintenance, and providing food on the premises. However, they do not include support costs such as clothing or medical and education expenses.

We want to ensure that you are taking advantage of all appropriate tax saving strategies. Please call us if you would like to discuss questions or concerns about the requirements for HOH filing status.

Gifting Appreciated Securities

The 2003 Tax Act reduced the tax rate on long-term capital gains and dividends to a mere 5% when the taxpayer is in the 10% or 15% rate bracket. So, gifting away appreciated securities (particularly up to the $11,000 annual gift tax exclusion) to low-bracket relatives could result in lower taxes overall. As long as the combined holding periods of the donor and donee aggregate to more than one year, the low bracket donee can sell the appreciated securities and pay only 5% in federal income taxes on the resulting long-term capital gain. The low bracket donee also pays only 5% in federal income taxes on qualified dividends collected after receiving gifts of dividend-paying stocks.

Consider the situation of a college-bound child. The parent can transfer appreciated securities to the child who then pays only 5% in federal income taxes on any gain when they are sold to pay college bills and for the child's general support. (The effect on the student's ability to qualify for student loans and other financial aid should be considered prior to initiating any gifting strategy.) The same low rate applies to qualified dividends collected from dividend paying shares the child receives as gifts. This strategy may also allow the child to claim a personal exemption for him or herself because he or she is now independently able to cover over 50% of his or her support. In contrast, the high-income parent may get little or no tax benefit from claiming a dependency exemption for the child due to the exemption phase-out rule (which for 2004 kicks in at an adjusted gross income of $214,050 for joint filers).

President Signs Military Relief Bill

President Bush recently signed the Military Family Tax Relief Act of 2003, which increases the death gratuity payable to survivors of military members killed in the line of duty from $6,000 to $12,000, and makes the full payment tax exempt. Other provisions were set in place to:

· Expand the gain exclusion for home sales by military and Foreign Service personnel
by allowing more time to meet the two year ownership and use requirements.
· Extend the combat zone filing rules to contingency operations.
· Clarify the tax treatment of certain dependent care assistance programs.
· Suspend the tax-exempt status of designated terrorist organizations and deny deductions
for contributions to such organizations.
· Provide an above-the-line deduction for overnight travel, meals, and lodging expenses
of National Guard and Reserve members.

Locate the Best Place to Retire with This Website

The editors from Money magazine list their top selections of the best places to retire at www.money.cnn.com/best/bpretire/. To determine the best places to retire, Money magazine's editors concentrated on locales with solid financial footing and good health care options. A significant amount of information is available for each selection. In addition to the selected cities, you can request a great deal of information on any city of your choice. Selected topics for each city include weather, financial, housing, leisure, culture, travel, healthcare, environment, crime, and education.

This website also has a Cost of Living Calculator which allows you to compare the cost to live in your present location with your selected retirement location. The calculator individually compares the cost of grocery items, housing, utilities, transportation, healthcare, and miscellaneous goods and services.

Deducting Business Start0up Costs

Start-up costs, as the name implies, are expenses incurred before a business actually begins. Start-up costs are not currently tax deductible, but may be amortized (gradually and evenly expensed) at the election of the taxpayer over a period of not less than
60 months starting with the month in which the active trade or business begins or is acquired.

Unlike start-up costs, organizational expenses are legal and accounting fees, incorporation fees, expenses of temporary directors, etc., that are associated with the creation of a corporation or partnership. They should be distinguished from start-up costs. Organizational expenses are not deductible when paid or incurred, but may be amortized at the election of the taxpayer over not less than 60 months starting with the month in which the company begins business.

Start-Up Costs Defined.
Start-up costs are expenses that would be deductible if incurred by an active trade or business, but do not include interest, taxes, or research and experimental expenses (whose treatment is governed by other statutory provisions). Startup expenses generally are segregated into two broad categories--investigatory expenses and preopening costs. Investigatory expenses are those incurred before reaching a decision to acquire or create a business. They include, but are not limited to, expenses for analyzing or surveying of potential markets, products, the labor supply, and transportation facilities.

Preopening costs are incurred after a taxpayer decides to establish or acquire a business, but before the day the business actually begins. Such costs include, but are not limited to, advertising, salaries and wages paid to employees being trained and their instructors; travel and other expenses incurred in lining up prospective distributors, suppliers, or customers; and salaries or fees paid or incurred for executives, consultants, and similar professionals.

Making the Election.
The election (a written statement) to amortize start-up costs must be filed with the income tax return for the year the business begins even if these costs are not actually paid until the following year.

Example: Amortizing start-up costs.

Jerry Jones is considering starting a uniform cleaning service, which he would own and operate as a proprietorship. In 2002, he incurred expenses of $5,000 for market research and assessing the labor supply. In early 2003, he decided to proceed with the project.
In addition to the actual construction costs, Jerry spent $7,500 for preopening advertising, wages paid to trainees, travel to line up financing, and temporary office expenses. The uniform cleaning service opened for business July 1, 2003.

Jerry should file an election with his 2003 federal income tax return to begin amortizing the $12,500 in start-up costs. He would elect to amortize the start-up costs over 60 months if he desires the most rapid write-off available.

Early Write-Off of Start-Up Expenses.
Unamortized start-up costs are fully deductible by an individual taxpayer as an ordinary loss if, before the end of the amortization period, the business or for-profit venture is disposed of or proves to be unsuccessful and terminates.

We are prepared to assist you to carefully break out and properly categorize the various types of expenses incurred when investigating, establishing, or acquiring a business.

Irrevocable Life Insurance Trusts

One of the best methods of keeping life insurance proceeds out of an estate, reducing estate taxes, and ensuring that the estate has necessary liquidity is to create an irrevocable life insurance trust (ILIT). Such a trust can remove assets from your estate (and the estate of your surviving spouse) and reduce your taxable estate. At the same time, the insurance proceeds are potentially available to meet the needs of both your surviving spouse and estate (e.g., the trust can purchase assets from the estate if liquidity is needed). For funding, an existing life insurance policy can be transferred to an ILIT or, alternatively, the ILIT can purchase a new life insurance policy.

Although an ILIT brings increased administrative and compliance costs when compared with holding an insurance policy outright, an ILIT generates the following benefits:

· As previously indicated, the trust can remove the insurance proceeds from your taxable estate and reduce your estate taxes, while making those proceeds available to your estate.
· You have the ability to select the trustee who will manage the insurance proceeds and specify how the proceeds should be invested.
· Under the terms of the trust instrument, you can determine when your beneficiaries (e.g., children or grandchildren) receive the insurance proceeds. Alternatively, you can provide the trustee with the discretion to decide the amount and timing of distributions.
· Assets in the trust, whether a life insurance policy or otherwise, are not subject to probate.
· Trust assets generally can be protected from the claims of your beneficiaries' creditors.

If you plan to transfer an existing insurance policy to the ILIT, the transfer must be made at least three years prior to your death. If you die within three years of transfer, the proceeds of that particular insurance policy will be included in your taxable estate and, thereby, eliminate the benefits of the ILIT. Purchasing a new insurance policy will alleviate this potential problem.

If you ultimately do establish an ILIT, a licensed attorney should prepare any trust documents.