Tax and Business Alert - March 2002

What’s new in 2002?

As most people are focusing on wrapping up 2001's taxes and finding out what they'll owe or get back as a refund, we thought it might be time for a little good news. Here's a quick rundown of some of the major tax benefits that are new (or improved) for this year.

·Lower tax brackets for everyone. The new 10% tax bracket is fully effective this year and the other brackets above the 15% bracket drop by .5% each.

·Qualified Tuition (Section 529) Plan payouts for education expenses are tax-free beginning this year, and as before, there's no taxable income limit on setting up or funding such a plan.

·Education Savings Accounts start the year with a fourfold increase in the annual contribution limit (from the old $500 limit to the new $2,000 limit). In addition, tax-free payouts can now be taken for precollege educational expenses.

· Adoption expenses are eligible for an enhanced tax credit or income exclusion (if employer paid) of up to $ I 0,000 per adoption.

· Roth and Traditional IRA contribution limits have jumped from the old $2,000 limit to a new $3,000 limit (or $3,500 if you're at least age 50 by year end).

·Elective deferral limits for 401 (k), 403(b), etc., plans rise to $ 11,000 (or $12,000 if you're at least 50 by year end). The deferral limit for SIMPLE plans is $7,000 (or $7,500 if you're at least 50 by year end).

·College tuition and fees are now generally deductible to the extent of the first $3,000 of costs for taxpayers with adjusted gross income (that number at the bottom of page I of your return) of up to $65,000 (or up to $130,000 if you file jointly with your spouse).

·Estate and gift tax exclusion jumps to $ 1 million this year. In addition, the annual gift tax exclusion rises to $ I 1,000.

·Employer matching contributions you receive because of compensation you defer into a 401(k) plan will now vest with you faster than before. The old rules allowed a maximum of either 100% cliff vesting in the fifth year or seven-year graded vesting. The rules applying after 2001 allow either three-year cliff vesting or six-year graded vesting.

·Student loan interest is more likely to be deductible because the deduction is no longer limited to the first 60 months that interest is due on the loan and the deduction phases out over a higher income range than before ($100,000 to $130,000 on a joint return and $50,000 to $65,000 on most other returns).

CONCLUSION

This is just a brief description of some of the major changes that arrive this year. Please call us if you'd like more details on any of these or the other changes from last year's tax bill that are scheduled to take effect in the next few years. 

Are You Being Taken for a Ride?

In recent years, it seems like everywhere you turn, there's a charity asking you to donate your old car in return for a great tax write-off. Yet, is what they're saying too good to be true?

The typical pitch is that they'll take your vehicle--running or not--and you pocket the tax savings and skip the hassle of having to sell the vehicle yourself. When done correctly and in the right circumstances, that's exactly what happens--it's a win-win deal for both you and the charity.However, sometimes the tax deduction doesn't turn out as promised (or at least as implied).

One of the biggest roadblocks to claiming a deduction is that if you're one of the approximately 70% of taxpayers who don't itemize deductions, the donation won't reduce your taxes at all.  Even if you do itemize, you won't benefit from the donation unless it's made to an organization that's a qualified charity.   (Some of the outfits soliciting vehicle donations are not charities but a front for a for-profit business.)  And finally, the law allows you (assuming you get the proper documentation) to deduct the donated vehicle's market value. Effectively, this is the amount you would receive if you sold the vehicle to an unrelated party (meaning the vehicle's condition, mileage, etc., have to be factored in. Unfortunately, some car donation operators have strongly implied that you can always claim a car's full "Blue Book" value.         

Interesting Websites

Homework Central. With mid-terms and class projects looming and those regular homework assignments creating a steady grind, the Internet is an invaluable resource for students and their parents. A couple of helpful sites we've come across recently are HomeworkSpot.com (which does a good job separating help by grade level and by subject, and serves as a portal to scores of related sites) and DiscoverySchool.com (which includes links to tutors, access to a clip art gallery for illustrating class projects, and numerous other information sources).

Of course, sometimes the really tough questions come from the inquiring minds of youngsters who aren't even formally in school yet. Thus, when you get stumped by one of those "How does __ work?" questions, you might want to check out HowStuffWorks.com to see if they've got the answer.

Used cars. New cars are certainly nice, but a previously owned vehicle generally offers a better value for your money. Of course, one of the problems with buying used is getting stuck with someone else's problem. Besides a good mechanic, another way to check out a used vehicle is to do a title search--to check for things such as retitling after a car was involved in a wreck or repurchased as part of the manufacturer's buyback program under the lemon laws. In return for a small fee, if you have the vehicle identification number, you can do a title search and check for other problems such as an odometer rollback at www.carfax.com.

Working at Home.

Whether it's a desire to hold down expenses while starting a new business, or simply a matter of telecommuting a few days a month, a home office can be a great place to get the work done. But what about the tax ramifications of such an arrangement? Will Uncle Sam help pick up part of the costs?

If you're an employee, the answer is typically "No." The business use of the home must be for the employer's convenience (tough to prove if you have a regular office) and the space must be used exclusively and regularly for job-related activities.

If you're self-employed, claiming deductions is generally easier. The space must be used regularly and exclusively as (1) a principal place of business, (2) a place to meet or deal with clients/customers, or (3) a separate structure (such as a detached garage or barn) used in connection with the business.

Any deduction allowed is limited to the business's net income. Thus, it can't create or increase a business loss. However, any expenses disallowed because of this limitation can be carried over to later years (subject to the same net income limitation). Having a qualifying home office can also help you deduct more of your transportation costs because going from your home to another business site then becomes a deductible trip.

If you think you qualify for a home office deduction, please call us so we can go over all the rules and discuss such issues as what the tax implications are when the house is sold.

Inflation-adjusted I Bonds

In the not-too-distant past, people would have died laughing if you'd tried to get them excited about investing in something earning around 4% annually. However, after two tough back-to-back years in the stock market, making 4% to 5% a year is starting to look better -especially when the investment in question includes some protection against inflation.

Is there such an investment? Yes. Inflation-adjusted Series I U.S. Savings Bonds, or I Bonds as they are commonly called, are now starting to get some well deserved attention. Here's what you need to know about them.

THE BASICS

Series I U.S. Savings Bonds (I Bonds) are a variation of the familiar Series EE U.S. Savings Bonds (EE Bonds). Like EE Bonds, I Bonds earn interest for up to 30 years or until redemption, whichever comes earlier. The federal income tax hit on the accumulated interest income is deferred until redemption (unless you elect to recognize the interest annually). This means federal income taxes on the interest income can be deferred for up to 30 years. In addition, I Bond interest is exempt from state and local income taxes (as is EE Bond interest).

Like EE Bonds, I Bonds can be purchased for small amounts. They are sold for face value. (In contrast, EE Bonds are sold for 50% of face value.) Currently, the following I Bond denominations are available: $50, $75, $100, $200, $500, $1,000, $5,000, and $I 0,000.   As is the case with EE Bonds, the maximum annual face amount an individual can invest in I Bonds is limited to $30,000.

Of course, I Bonds are backed by the full faith and credit of the U.S. Government, just like EE Bonds and other debt securities issued by the U.S. Treasury.

I Bond interest accrues monthly and is compounded semiannually. An I Bond can be redeemed for cash at any time six months after purchase or later. However, the government charges an interest penalty when an I Bond is redeemed within five years of purchase.

How Is I Bond Interest Calculated

An I Bond's interest rate is composed of two separate rates: (I) a fixed rate of return that is determined at issue and that continues to apply for the 30-year life of the Bond, and (2) a variable rate of return equal to the current inflation rate, which is redetermined on a semiannual basis.

The fixed rate of return component is announced by the Treasury Department each May and November. The fixed rate of return announced in May is the same over the entire 30-year life of all I Bonds purchased between May I and October 31 of that year. Likewise, the fixed rate of return announced in November applies to the entire 30-year life of all I Bonds purchased between November I of that year and April 30 of the following year. The current fixed rate is 2% annually. That rate applies to all I Bonds issued between November I, 2001 and April 30, 2002.

The variable rate of return component (equal to the semiannual rate of inflation) is also announced each May and November and is based on changes in the Consumer Price Index (CPI). The rate announced each May is a measure of inflation over the preceding October through March. The rate announced each November is a measure of inflation over the preceding April through September. The current semiannual inflation rate announced in November 2001 is 1.19% (2.38% annually).

The fixed rate is then combined with the current semiannual inflation-adjustment rate to determine the overall I Bond rate to be paid over a six-month period. The rate paid on a given I Bond over the subsequent six-month period will be the same fixed rate plus the updated semiannual inflation-adjustment rate. In computing the fixed return, the I Bond principal amount is increased by the inflation adjustment. Interest is accrued on a monthly basis at the indicated rate and is compounded on a semiannual basis.

Buying the Bonds

I Bonds can be ordered at most local financial institutions. The I Bond is then mailed to the purchaser about three weeks later. I Bonds are also sometimes available through employer-sponsored payroll savings plans. In addition, they can be purchased online at: www.savingsbonds.gov (click on the "1 Bonds" link and then on the "Savings Bonds Direct" link).     

Good News if You Own an Eating or Drinking Establishment

For years, restaurants and bars and the IRS have had a running battle over the proper tax treatment of what is commonly called smallwares cost. In the past, the IRS has been known to take the position that such costs should be capitalized rather than expensed during the tax year in which they are incurred. However, the IRS recently gave in on this issue.

The IRS announced that it will allow businesses in the retail food and beverage industry such as restaurants, bars, and caterers, along with other businesses that serve food or beverages to the general public to deduct smallwares expenses when the costs are incurred. This is clearly a victory for taxpayers compared to the prior position of the IRS.

To be eligible for this new expensing option, most businesses will need to file a special IRS form with their first tax return for a year ending on or after December 3 I, 200 I. If this form is filed, IRS approval of the adoption of the new method is automatic.

What Counts as Smallwares Cost?

For purposes of this new expensing option, smallwares consist of a surprisingly large group of items. For example, glassware, along with paper and plastic cups; flatware (silverware) and plastic utensils; dinnerware (dishes), as well as paper and plastic plates; and pots and pans are all included. In addition, the following categories of items are included.

Table top items. These include items placed on customer tables, such as salt and pepper shakers, tablecloths, napkins, menu holders, menus, vases, candles, and candleholders.

Bar supplies. These include mixing glasses, bar strainers, cutting boards, liquor pourers, jiggers, corkscrews, bottle openers, storage bottles, bar caddies, wine coolers, and decanters.

Food preparation utensils and tools. These include hand utensils, pastry and grill brushes, cutting boards, strainers, colanders, shakers, dippers, gloves, goggles, timers, scales, shaker baskets, salad spinners, lettuce crispers, sifters, pastry bags and tubes, mixing bowls, pot holders, kitchen towels, and kitchen staff uniforms.

Storage supplies. These include food and dish containers, flatware sorters, and spice racks.

Service items. These include pepper mills, cheese graters, bread boards, coffee pots, serving trays, soup and salad bar trays and containers, bus tubs, tray carts, booster seats, and wait staff uniforms.

Small appliances. These include iced tea dispensers, can openers, condiment pumps, individual food warmers, heat lamps, blenders, juicers, and nonindustrial mixers. Small appliances do not include items that cost in excess of $500.

CONCLUSION

This new IRS provision on expensing smallwares cost is good news. If you have questions about it or want clarification on how it might apply to your business, please call us.

The Tax and Business Alert is designed to provide accurate information regarding the subject matter covered. However, before completing any significant transactions based on the information contained herein, please contact us for advice on how the information applies in your specific situation. Tax and Business Alert is a trademark used herein under license.