Tax and Business Alert - 

May 2005

If you have ever had to go back and find mutual fund records from several years in the past, you know how painful that process can be. You may have been forced to search through several years of mutual fund and broker's statements or confirmations looking for mutual fund transaction information in order to have your tax return prepared. If you do manage to find those old statements, you may then be faced with computing the actual cost basis of your mutual funds after allowing for the reinvested fund distributions received each year, additional purchases, and partial sales. However, with an improved recordkeeping system and some careful planning, you can avoid the headaches associated with locating investment information, ease the cost basis computation burden, and increase the after-tax rate of return on your mutual funds as well.

If you elect to reinvest your periodic mutual fund distributions, as many investors do, those distributions generally increase your cost basis for determining taxable gain or loss. Even when your mutual fund distributions are reinvested, you pay taxes on those distributions in the year received [current taxation is not applicable to tax deferred accounts, i.e., 401(k), IRA, etc.] and each reinvestment is like making a new purchase with its own cost basis and holding period. Therefore when you sell or redeem your mutual fund shares, it's critical that you include that additional cost basis when computing your gain or loss. If you don't, you may be paying double tax since you were already taxed in the year the distribution was received. Keeping track of that additional cost basis can be complicated, but necessary.

When you sell or redeem mutual fund shares without liquidating your entire investment position in the fund, you have several choices for determining how much cost basis is assigned to the shares sold. If you have purchased shares at different dates and prices, the method used can significantly affect the amount of taxable gain or loss and the holding period, which in turn determines whether you qualify for the preferential long-term capital gain tax rates.

Please call us for ideas to better track your mutual fund investments and save on taxes as well.

Golf Coach Shanks Club Membership Fee Deduction

At issue in a recent Tax Court case was whether a high school golf coach could deduct golf club membership fees as ordinary and necessary business expenses. The coach's country club membership enabled the golf team to use the club's practice putting green three times per week for free, and the coach had unlimited access as a member to the club's facilities to maintain his golf skills.

After noting that expenses paid for membership in "any club organized for business, pleasure, recreation, or other social purpose are not deductible," the Tax Court noted that: "No one, including golf professionals or instructors, may deduct club dues."

More Hondas Certified for the Clean-fuel Deduction

The IRS has certified the 2005 Honda Insight, the 2005 Honda Civic Hybrid, and the 2005 Honda Accord Hybrid as eligible for the clean fuel vehicle deduction. The original owner of one of these vehicles can claim a tax deduction in the year the vehicle is originally used. For 2004 and 2005 the deduction amount is up to $2,000. The deduction will be limited to $500 for vehicles first put into service during 2006. Currently, no deduction will be allowed after 2006. The benefit can be taken as an adjustment to income on your tax return and you don't need to itemize to claim this deduction.

The 2005 Ford Escape and 2005 Toyota Prius were previously certified as eligible by the IRS and continue to qualify for the clean-fuel vehicle deduction. The IRS had also previously certified the Honda Insight for 2000-2004 and the Honda Civic Hybrid for 2003 and 2004, along with several Toyotas.

IRS Charitable Contributions Information Website

Charitable contributions are deductible as itemized deductions. The amount of charitable deductions an individual can claim in any one year is limited depending on the types of organizations to which the contributions were made, the kinds of property contributed, and the amount or value of the donated property.

IRS Publication 78 contains a list of charitable organizations eligible to receive tax-deductible contributions. You can access the charitable organization information online at http://apps.irs.gov/app/pub78. You will need the organization's name and location to perform your search. Available information includes a coding system to identify each organization by type and limitation on deductibility. Note that the IRS states their list is "not all-inclusive."

Please call us with questions you have about anticipated charitable contributions or charitable giving strategies.

Electronic Tax Payments

In simpler times, most businesses were .allowed to make their federal tax payments by depositing a check (with Form 8109) at their local bank. Now, in this technological age, many businesses are required to make their tax payments electronically through the Electronic Federal Tax Payment System (EFTPS). Recent enhancements to the online version of the EFTPS and the offering of an incentive for voluntary use of the system make electronic tax payments more attractive than ever Accordingly, many businesses that still have a choice between the paper approach and the electronic route may wish to consider taking the leap into the 21st Century and embracing electronic tax deposits.

Who must use EFTPS? Businesses with total tax deposits (for payroll taxes, income taxes, back-up withholding, etc.) exceeding $200,000 in a particular year must make payroll deposits using EFTPS in the second succeeding year For example, a business that exceeds $200,000 of tax deposits for the first time in 2004 must begin making electronic tax deposits effective for the return periods beginning on or after 1/1/06. Once a taxpayer is required to make electronic tax deposits, it must continue to do so even if its tax deposits later drop below $200,000 a year Note, however, that a taxpayer who does not meet the $200,000 threshold but voluntarily uses EFTPS is allowed to switch back to paper coupons without any penalty.

Taxes subject to EFTPS. The $200,000 threshold applies to aggregate federal tax deposits, not just employment tax deposits. Therefore, when determining if total tax deposits exceed the $200,000 threshold, businesses must consider the following types of deposits:

· FICA taxes (employer's and employee's share)
· FUTA (unemployment tax)
· Railroad retirement taxes
· Income tax withholding (including backup withholding)
· Corporate income and estimated income taxes
· Tax withheld from nonresident aliens and foreign corporations
· Estimated tax payments by financial institution fiduciaries for certain trusts
· Excise taxes

If a taxpayer meets the $200,000 threshold, all of the above taxes must be deposited using
EFTPS. Taxpayers that do not meet the $200,000 threshold can voluntarily deposit any of the above taxes using EFTPS.

Penalty for failing to use EFTPS. Taxpayers who are required to deposit federal taxes via EFTPS will be assessed a failure-to-deposit penalty of from 2% to 15% of the underpayment amount even if a paper deposit is made on time.

One-time "reward" for voluntary use of EFTPS. To encourage use of EFTPS by taxpayers that are not required to use it, the IRS has created an EFTPS federal tax deposit penalty refund offer. This is an incentive in the form of an automatic one-time penalty refund on a previously assessed deposit penalty on Form 941 (Employer's Quarterly Federal Tax Return). The refund is only available to employers who are not mandated to use EFTPS. To qualify for the offer, the employer must:

- use EFTPS for one year,
- make all Form 941 payments on time, and
- have previously fully paid the penalty.

Refunds will be automatic; there is no need for employers to apply for them.

EFTPS is here to stay. If your business is approaching the $200,000 threshold and has incurred a refundable penalty, now is a great time to consider EFTPS. Even if a penalty refund is not in the cards, voluntary use of EFTPS may make sense if you are comfortable with the technology, want to have online access to your payment history, and would like to save trips to the bank.

Tax Advantages with Small Business Stock

As you may be aware, gains and losses on sales of corporate stock owned personally are generally treated as capital gains and losses. Although capital gains are potentially taxed at preferential rates, capital losses are usually unattractive because the losses can only offset capital gains plus $3,000 of ordinary income (from wages, dividends, interest, etc.). Thus, if you realize large capital losses, but no capital gains, the tax benefit from the capital losses may have to be spread over many years in the future.

However, there is a tax provision (known as Section 1244) that allows you to treat losses incurred from the sale of qualified corporate stock as ordinary (rather than capital) losses. That's beneficial because an ordinary loss offsets ordinary income. The deductible ordinary loss for this provision is, however, subject to an annual limitation of $50,000 ($100,000 if you file a joint return).

Of course, you don't intend for your new business to generate a loss; however, this tax provision is like insurance--you hope you will not need it, but it's nice to have it just in case. Any gain on the sale of Section 1244 stock is capital gain and qualifies for the favorable capital gains tax rates. Only losses are characterized as ordinary. Thus, there's really no downside to qualifying for Section 1244 treatment if your initial capital structure can be set up to meet the requirements.

To qualify as Section 1244 stock, your new business must be a U.S. corporation (including an S corporation) and it must have no more than $1 million in capitalization at the time the stock is issued. The stock must be issued to an individual or partnership in exchange for money or property (other than stock or securities). Stock issued in exchange for services will not qualify. In addition, the corporation must derive more than half of its gross receipts from non-investment activities for a specified period (generally five years) before the year the stock is disposed of at a loss.

Only stock issued when the corporation's total capital receipts are $1 million or less can qualify as Section 1244 stock. Once the corporation has received capital in excess of $1 million, no additional Section 1244 stock can be issued. However, stock issued before the $1 million limitation is met continues to qualify as Section 1244 stock if it qualified when issued.