Tax and Business Alert - May 2003

"Dirty Dozen" Common Tax Schemes and Scams

The IRS recently updated its list of the 12 most common tax schemes and scams to avoid. The Service noted several new scams have reached the top of their consumer watch list including offshore transactions and identity theft. The 12 most common schemes and scams are:

1. Offshore Transactions

Some taxpayers use offshore transactions to avoid paying U.S. income tax. Underreporting income or claiming false deductions through the use of offshore credit cards, trusts, or other arrangements is illegal.

2. Identity Theft

In one case, fraudsters sent bank customers fictitious bank correspondence and IRS forms in an attempt to trick them into disclosing their personal and banking data.

3. Phony Tax Checks

Con artists sell fictitious financial instruments called "sight drafts" that look like checks to pay a tax liability. It is illegal to use these drafts.

4. African-Americans Get a Special Tax Refund

Thousands of African-Americans have been misled by people who, for a fee, offer to file for tax credits or refunds related to alleged slavery reparations. There is no basis for any such provision in the tax law.

5. No Taxes Withheld from Wages

Employers are encouraged not to withhold federal income tax or employment taxes from wages paid to their employees. Court action is being taken against promoters of this scheme.

6. Improper Home-based Business

Promoters encourage taxpayers to deduct personal expenses as business expenses by setting up a bogus home-based business.

7. Pay the Tax--Get a Prize

A caller indicates the taxpayer has won a prize and must pay him/her the income tax due to collect the prize. The trouble is, there is no prize.

8. Frivolous Arguments

Frivolous arguments are false statements that are unsupported by law. This is an old scheme getting new life on the Internet. Taxpayers are told that for a fee (i.e., $49.95), they will be shown how to free themselves from income taxes forever. The promoter keeps the fee and the taxpayer receives no benefit.

9. Social Security Tax Scheme

Taxpayers are told that they can receive a refund of all the Social Security taxes paid during their lifetime. The victim is told that for a "paperwork fee" of $ 100 and a percentage of the refund received their claim will be processed. There is no such program. The promoter pockets the $ 100 fee and the victim receives nothing.

10. Receive a Big Refund for a Fee

Taxpayers are given a phony W-2 that will ostensibly qualify them for a big refund. In return, the promoter receives a portion of the refund. The IRS catches most of these refund claims before they go out.

11. Share or Borrow Earned Income Tax Credit (EITC) Dependents

Unscrupulous tax preparers share a client's dependents with another to allow both clients to claim the EITC. Participating taxpayers could be subject to civil penalties.

12.1RS Agents Come to Your Home to Collect Taxes

IRS special agents, field auditors, and collection officers carry picture IDs and will normally try to contact you before they visit. Be cautious when allowing anyone access to your home or business.

The IRS has given us a list of tax schemes and seams to avoid. Please call us to discuss legitimate tax-saving techniques.

The Deemed IRA - An IRA Inside Your Qualified Employer Plan

Beginning in 2003, a qualified retirement plan or annuity can accept voluntary employee contributions into separate traditional IRAs and Roth IRAs (Deemed IRAs). If the qualified employer plan meets certain specific requirements, the Deemed IRAs will be treated in the same manner as traditional IRAs and Roth IRAs within the provisions of the Internal Revenue Code. Eligible plans include 401(a), 401(k), ESOP, 403(a) and 403(b) annuity, and 457(b) plans. Assets within the Deemed IRAs can be commingled with other plan assets for ease of management. A participant contributing to a Deemed IRA can take advantage of the plan's administration and investment services.

Contributions to Deemed IRAs are subject to the normal IRA contribution limits, i.e., up to $3,000 in 2003 ($3,500 if age 50 by year-end). Employers cannot make contributions to a Deemed IRA; only voluntary employee contributions can be made. Deemed IRA contributions are counted with and not in addition to other IRA contributions when considering the annual limitation...no double dipping. But, you can continue to make your regular retirement plan contribution, which is not reduced by any Deemed IRA contributions. Adjusted gross income limitations that impact allowable contributions, deductions, and rollovers apply to Deemed IRAs just as they would outside the employer plan.

Interesting Investment Websites

If you are a sophisticated investor, you just might find Single Stock Futures (SSFs) intriguing. An SSF contract is an agreement to deliver 100 shares of a specific stock at a designated date (expiration date) in the future. Margin requirements are generally 20% and no "uptick" is required to establish a short position. If you believe the price of a particular stock will increase, you buy or "go long" an SSF contract on that stock. Conversely, if you think the price of a stock is going down, you sell or "go short" an SSF contract on that stock. SSF contracts are available for many NYSE and NASDAQ listed companies.

A great deal of information on SSFs is available from two websites. The NQLX at www.nqlx.com and One Chicago at www.onechicago.com websites explain the basics of SSFs and have a comprehensive list of frequently asked questions (FAQs). A glossary of appropriate terms and a listing of useful web links are provided. A list of companies eligible for trading is also available.

Most investors can benefit from BigCharts at www.BigCharts.com, which provides stock charts and a host of additional financial market information and news. The BigMover reports list stocks with the largest percentage price gain, price loss, gain in volume, and loss in volume in addition to 52-week highs and lows, most active stocks, and largest money movers. The BigPick reports include stock charts ranked by percentage change in price and volume and the largest money movers. The BigMarket reports include broad market overviews, Dow Jones index reports, recent corporate earnings releases, and a list of stocks with the largest short interest.

Transactions that must be reported are those that an MSB knows or suspects:

Beginning March 1, 2003, businesses that issue or redeem money orders or traveler's checks are required to use a new form to report suspicious activities to the IRS. More than 200,000 money service businesses (MSBs), including convenience stores, grocery stores, service stations, drug stores, and liquor stores, must file Form TDF 90-22.56 when they process a money service transaction that is both suspicious and for $2,000 or more. The U.S. Postal Service also uses this form.

· Involve funds derived from an illegal activity or are intended or conducted in order to hide or disguise funds derived from an illegal activity.
· Are designed to evade the requirements of the Bank Secrecy Act.
· Serve no business or apparent lawful purpose, and the reporting business knows of no reasonable explanation for the transaction after examining all available facts.

Claiming a Dependent Parent Exemption

Generally, you can claim a dependency exemption for your parent only if you provide more than half of his or her support for the year. In determining the amount of support provided to your parent, the value of lodging (whether provided by you or your parent) is included in the support test. If the lodging is either your residence or other property, the fair rental value of the lodging is included in calculating the parent's support. If your parent owns the residence, its fair rental value is considered support your parent provides on his or her own behalf. (Fair rental value is the amount one could reasonably expect to receive from an unrelated individual for the same kind of lodging.) Because a parent is a relative, he or she need not live in your household to be claimed as your dependent.

If you support both parents, your support is deemed to be provided equally for both, unless you designate otherwise. Notations on your support checks are regarded as evidence of actual support.

Example: Meeting the support test to claim your parent as a dependent.

Frank and Rose Miller support Rose's widowed mother, Norma, who is 68years old. Norma lives rent-free in one side of a duplex the Millers own. The fair rental value of the dwelling (unfurnished) is $8,400 per year. Norma provides her own furniture, but the Millers pay the utilities totaling $1,200. Norma's income consists of Social Security benefits of $8,000 and $300 of interest income, all of which she spends toward her support. The annual fair rental value of Norma's household furnishings is $1,200.

The Millers provide more than half of Norma's support. Their support is $9,600 ($8,400 value of the dwelling plus $1,200 utilities) while the support Norma provides for herself is $9,500 (income of $8,300 plus the $1,200 value of furnishings). Norma also meets the other dependency tests (i.e., relationship, citizenship, joint return, and gross income). Thus, the Millers can claim Norma as a dependent on their joint tax return.

A special exception to the support rule exists for multiple support situations (e.g., where several children contribute to the support of a parent). Where qualified taxpayers each provide more than 10% of an individual's support and 50% collectively, they can decide among themselves who will claim the exemption for their parent.

The following requirements must be met before a multiple support dependency exemption can be claimed:

The supported person must meet all of the dependency tests (i.e., relationship, citizenship, joint return, and gross income) except the more than 50% test.
The taxpayer claiming the exemption must obtain the consent of each of the other taxpayers who pay more than 10% of the support and could, except for the more than 50% test, otherwise claim the supported person as a dependent.
The taxpayer claiming the exemption must be able to claim the supported person as a dependent, except for the more than 50% test.

Example: Claiming an exemption in multiple support situations.
Jane, Fred, and Al support their father, Steve, whose only source of income is $4,000 (28% of his required support) in Social Security. Jane and Fred each contribute $4,300 or 31% of Steve's support and Al contributes $1,400 or 10% of the total. No one child provided more than half the $14,000 required for Steve's support. Therefore, Steve's children must decide which of them is entitled to claim the exemption for Steve. Jane and Fred both qualify because they each provided more than 10% of Steve's support, whereas Al will not. Jane or Fred can claim the deduction for Steve in the current year. The election can change each year based strictly on that year's information.

Note: If an individual is claimed as a dependent on another person's return under the multiple support rules, no personal exemption is allowed for the dependent on his or her own return.

Estate Planning in a Second Marriage

Estate planning when one or both of you have been previously married may cause you to address certain sensitive issues for the first time. You may have conflicting ideas about your estate planning goals. For example, you may or may not intend for children from prior marriages to be treated the same as children from the present marriage when it comes to estate planning. Unhappy heirs, especially when conflict is present, are often the ones who contest a will and question the use of certain estate planning techniques. Thus, documenting your wishes is extremely important.

Marital and Prenuptial Agreements

Marital agreements can be executed during marriage, but generally it is advisable to resolve such issues before marriage. Many potential problems between spouses can be avoided by executing a valid premarital agreement. Generally, the marital agreement is used to identify the property rights of the parties. The categories of property, such as separate and community, should be clearly identified.

In addition to identifying and categorizing all property, a settlement provision (in the event of separation or divorce) may also be included in a marital agreement. Examples of specific property to include in such a provision are a personal residence, pets, family heirlooms, and other personal property. The marital agreement may require you to execute a will or other agreement to provide for the property rights outlined in the marital agreement.

Incapacity Planning

In the event of incapacity, many problems may arise, particularly when there are children of the incapacitated spouse from a prior marriage. Each of you should address how financial decisions should be made, who would make them, how to manage assets, and how to carry out the incapacitated spouse's obligations.

Retirement Plan Assets

Your most valuable asset may be your qualified retirement plan or IRA. In a second marriage, where there are children from a prior marriage, you must address the issue of providing for both your spouse and children as well as complying with the income tax laws regarding retirement plan contributions, distributions, and designated beneficiaries. For example, if your spouse is the beneficiary of your qualified retirement plan, your children from a prior marriage may not necessarily receive any benefits from your plan.

Life Insurance

Life insurance may be necessary to equalize distributions between your surviving spouse and your children from a prior marriage. Life insurance can balance the division of estate assets if your estate includes a closely held business interest or other assets that comprise a sizable portion of your estate but must be kept intact (i.e., not partitioned). Your surviving spouse can be named the beneficiary of a life insurance policy, and your children from a prior marriage can receive the family business. Similarly, if your spouse is the beneficiary of your retirement plan assets, life insurance can help equalize distributions to your children from a prior marriage.

QTIP Trust

A qualified terminable interest property (QTIP) trust is often recommended when you have children from a prior marriage. This type of trust allows you to provide current income to your surviving spouse for life, and provides that your property will pass to your children from a prior marriage when your surviving spouse dies.