Tax and Business Alert - June 2002

DOCUMENTING CHARITABLE GIFTS

Although your primary motivation for making a donation is likely not the tax savings, there's no reason to let an otherwise allowable deduction go to waste.   Thus, it's important to be familiar with the tax law's requirements for documenting your charitable gifts.

To help you substantiate your 2002 donations, we've provided this quick summary of the rules. If you have any questions concerning how they apply to your particular situation, please don't hesitate to call us.

CASH GIFTS

For gifts of $75 or less, a cancelled check, receipt, or other record showing the charity's name, plus the amount and date of the donation, is all that's required. If the gift exceeds $75 and you receive something other than de minimis items (such as a calendar or key chain) in return for the donation, the charity is required to give you a receipt showing its estimate of the value of the goods or services you received. However, the failure to receive such a receipt doesn't affect your deduction.

In contrast, gifts of $250 or more are simply not deductible unless the donation is properly acknowledged by the charity. The acknowledgment must include the amount of cash and a description of any other property given and a statement indicating whether the charity provided any goods or services in return for the donation. With the exception of certain intangible religious benefits (such as the right to attend a worship service), any goods or services that were provided to the donor by the charity must be described and an estimate of their value must be included on the receipt-along with a statement saying that only contributions in excess of this value are deductible. The acknowledgment normally must be received before your return is filed (a special one-time exception applied to contributions made after September 10, 2001, and before January 1 of this year).

OUT-OF-POCKET EXPENSES

A volunteer's unreimbursed expenses generally can be substantiated simply by maintaining written records showing the date, amount and reason for the expense. However, if such expenses total at least $250 for a single charitable event (such as chaperoning a multi-day field trip for a school or church group), you must receive an appropriate acknowledgment from the charity before the deduction is allowed.

NONCASH GIFTS

Gifts of property are generally subject to the same substantiation requirements as cash gifts (including the special rule for donations of $250 or more). However, when the value of noncash donations exceeds $500 for the year, the original costs of the items and how and when they were acquired also need to be documented.  Finally, when a noncash gift (or multiple gifts of similar items) exceeds $5,000, you generally must have an appraisal prepared before the donation is made.

VAT REFUNDS

If you're planning a trip outside of the United States this year, chances are you can lower the trip's cost.  How?  By seeking a tax refund.

Although surveys differ on the exact amount, Americans traveling to other countries are leaving millions (if not billions) in unclaimed value-added tax (VAT) refunds behind on goods and services they purchase while away from home.  Known in many countries by another name (such as IVA, TVA, MWST, or MOMS), the VAT is a hidden tax (ranging from a Iow of 7% to well over 20% in some countries) that's tacked on at every stage of production.

The goods and/or services eligible for refunds vary from country to country. In addition, each country sets a minimum, ranging from around U.S. $15 to as much as U.S. $350, that must be spent in a single purchase to be eligible for a refund. However, once you hit this minimum, seeking a refund is pretty easy. For example, tourists typically can claim a refund by getting appropriate documentation at the time of purchase and then showing this documentation to customs officials upon leaving the country. For business travelers, the process can be a little more involved and frequently is left to a company specializing in VAT refunds--such as Global Refund (www.globalrefund.com) or Cash Back (www.unitedcashback.com).

THE IRS SAYS KEEP ON TRUCKING

Ryeplacing the tires on your family vehicle can set you back several hundred dollars. While that's not an insignificant expense to most people, it pales in comparison to the costs of replacing the tires on a typical business vehicle--from a delivery van to an 18-wheeler. Thus, perhaps it is not too surprising that the tax treatment of how to account for these costs (and the costs of the original tires that come with the vehicle) has been a source of friction between businesses and the IRS.

The problem is that as tires have improved in quality over the Iast 20 or 30 years, the IRS has increasingly insisted that businesses capitalize their costs (whether acquired with the original purchase of a vehicle or as replacements for worn-out tires) and depreciate them as assets separate from the vehicles they're installed on. Depending on the type of business the vehicle is used in, this can result in a depreciable life of as much as seven years.

Thanks in part to the behind-the-scenes efforts of some trucking companies, the IRS recently announced a new safe harbor method of accounting for the cost of original and replacement tires for most trucks used in business. Although perhaps designed with the large interstate long-distance haulers in mind, this new method [referred to as the original tire capitalization (OTC) method] is available to almost any taxpayer that uses one or more trucks in its business. The OTC method, which is optional, allows a business to treat the tires that come with a vehicle as part of the vehicle's depreciable cost rather than as a separate asset. Then, if the tires are replaced, the cost of the replacements becomes a deductible expense in the year the switch is made. That's a reasonable method and probably what the IRS should have been allowing all along.

INTERESTING WEBSITES

Frequent flyers. The Web is filled with travel sites, from the airlines' and hotels' own sites to the consolidators and travel search engines. If you're traveling for pleasure and have some flexibility in your schedule, searching several of these sites can help you come up with some great deals. However, if you're a frequent business traveler, your needs are generally different. One of the best sites we've found to help business travelers keep up with all of the latest mileage and awards deals and get tips on squeezing the most from their travel budgets is Randy Petersen's WebFlyer.com or the related (fee-based) Flyerguide.com.

Retirement plans. Last year's tax bill made lots of improvements to the tax rules related to employer-sponsored retirement plans. However, these changes don't do you any good if the business you work for doesn't offer a retirement plan. Whether you're the owner of the company or just an employee who'd like some assistance saving for retirement, the U.S. Department of Labor's Small Business Retirement Savings Program Advisor (www.dol.gov/elaws/pwbaplan.htm) can help get you (or your employer) started in the right direction. The site includes a side-by-side comparison of the various features and filing requirements for the major retirement plan choices. Also, we'd be glad to help you sort through the choices available--just give us a call. When it's time for retirement, you'll be glad you did.

REDUCING THE AFTER-TAX COSTS OF MEDICAL EXPENSES

Even if you're fortunate enough to have comprehensive medical coverage, you've probably noticed your out-of-pocket expenses keep going up every year. From co-pays and deductibles to premium-sharing and noncovered expenses, medical expenses seem out of control. However, with employers, the medical profession, and even the insurance companies all voicing concerns that they're also struggling with health care costs, it's unlikely you'll see much relief from any of these sources. So where can you turn for help?

TAX RULES TO THE RESCUE

It's no secret the itemized deduction for medical expenses is virtually worthless. Such expenses are only deductible to the extent they exceed 7.5% of your adjusted gross income (the number at the bottom of page I of your return). Even then, the excess expenses plus your other itemized deductions must exceed what's referred to as the standard deduction before they actually benefit you. Fortunately, that's not the end of the story. There are several ways to get a tax benefit from your out-of-pocket medical expenses. How you go about it, however, generally depends on whether you're self-employed or work for someone else.

HELP FOR THE SELF-EMPLOYED

Self-employed individuals can normally claim an income tax deduction for 70% of the premiums paid for medical, dental, and long-term care insurance coverage for themselves and their families. (The percentage rises to 100% next year.) A sole proprietor, an individual with Schedule F (farming) income, a partner, a member of an LLC taxed as a partnership, and an
S corporation employee who owns more than 2% of the corporation are all treated as self-employed for this purpose.

While receiving a 70% (or, next year, 100%) deduction for income tax purposes is OK, wouldn't it be nice if the deduction applied for self-employment (SE) tax purposes as well? In fact, wouldn't it be nice to write off all of your out-of-pocket medical expenses, not just the cost of the insurance premiums? Well, in some situations you can.

For self-employed individuals (other than S corporation owner/employees for whom this idea generally doesn't work), the key is that the spouse of the selfemployed person must be an employee of the business. This allows the business to provide health insurance (and, if desired, a self-insured medical reimbursement plan for out-of-pocket expenses) to the employee/spouse who in turn elects family coverage to cover the self-employed person and any children. Although the health insurance can be made available to the employee/spouse
without any restrictions (other than that the total salary and benefits the spouse receives must be reasonable in relation to the services provided to the business), the self-insured medical reimbursement plan is subject to some nondiscrimination rules. Thus, to get the maximum benefit from this planning idea, it's helpful for the spouse (or the spouse and other family members) to be the only employee(s).

OPTIONS FOR EMPLOYEES

Employees can get about the same tax benefit from their health care costs as the self-employed, but only if they have their employer's cooperation. For example, employees who have to pay a portion of the premiums on their employer-provided health insurance gain a tax advantage if the employer will set up a Section 125 cafeteria plan. With such a plan, employees can choose to pay their share of the premiums with pre-tax dollars (which saves both income and FICA tax). Even better, if the employer also offers what's normally referred to as a flexible spending account, employees can set aside a portion of their compensation on a pre-tax basis. They then use these funds to pay themselves for unreimbursed medical expenses incurred during the year. The key to using one of these accounts is to accurately estimate what your out-of-pocket expenses will be, because any funds left after all the year's qualified medical expenses are reimbursed will be forfeited.

A final option, that's available to both the self-employed and employees of businesses with an average of no more than 50 employees, is an Archer Medical Savings Plan. Using a combination of high-deductible health insurance and medical savings accounts into which tax deductible contributions can be made and from which tax-free distributions can be taken, such plans can save significant dollars in the right circumstances.

A LESS TAXING DIET

Okay, let's admit the obvious. Most of us have put on a few pounds since we left high school. A little here, a little there, and before you know ityour doctor is telling you it's time to lose a few pounds. If all of this has you thinking about signing up for a weight loss program or perhaps an exercise program at your local health club, the IRS is here to help.  In a recent ruling, the IRS explained two situations where taxpayers may be able to claim a deduction for at least some of the costs of a weight loss or exercise program. Here's the story.

JUST WHAT THE DOCTOR ORDERED

Two taxpayers we'll call Adam and Betty go to their doctor. Both are told that they need to lose weight-Adam because he's obese; Betty because she suffers from hypertension and her doctor feels she needs to lose weight to help treat her high blood pressure.

Adam and Betty both sign up for a weight loss program and pay an additional fee to attend periodic meetings. They also purchase reduced-calorie diet food items sold by the weight loss program sponsor. Neither of them is reimbursed by insurance or otherwise for the costs of the weight loss program or related food.

The IRS concludes that both Adam and Betty may deduct the costs of joining the weight loss program and attending the periodic meetings as a medical expense. The key is that they're doing this on the advice of a physician (advice that should be put in writing) as treatment for a specific problem rather than simply to improve their appearance, general health, or sense of well-being. However, the IRS says none of the costs for the special diet food are deductible because the foods are a substitute for what Adam and Betty would normally consume. Apparently this is true even though the diet food likely costs more than what they would typically spend on food.

Unfortunately, in many weight loss programs the cost of the food is by far the biggest expense. Still, the new IRS position offers taxpayers the hope of getting at least some tax deduction if the non-food costs of a doctor-recommended weight loss or exercise program and the taxpayer's other out-of-pocket medical expenses exceed the threshold for claiming a medical expense deduction. Even better, taxpayers who have a flexible spending medical expense reimbursement plan at work may be able to reimburse themselves for such expenses on a pre-tax basis.

POTENTIAL REFUND OPPORTUNITY

In another bit of good news, the new IRS position is retroactive to all open tax years. Thus, if you've paid for a weight loss or exercise program in the last few years on the advice of your doctor, call us so we can decide together whether it might be worth amending a prioryear return to seek a tax refund.