Tax and Business Alert - November 2004

Year-End Tax Planning

There is still plenty of time to lower your 2004 tax bill, add to your tax advantaged retirement accounts, and do a little planning for next year Here are a few ideas to get you started.

IRAs. You can contribute up to $3,000 ($3,500 if you are age 50 or older by year-end) to your IRA for 2004 if certain conditions are met. For married couples, the combined contribution limits are $6,000 ($3,000 each) and $7,000 ($3,500 each if both are age 50 by year-end) when a joint return is filed provided one or both spouses had at least that much earned income.

The IRA contribution limit is scheduled to increase next year, creating an even better reason to increase your tax deferred savings. In 2005, you can contribute up to $4,000 ($4,500 if you are age 50 or older by year-end) to your IRA if you meet the requirements. For married couples, the combined contribution limits are $8,000 ($4,000 each) and $9,000 ($4,500 each if both are age 50 by year-end) when a joint return is filed and one or both spouses had at least that much earned income.

Annual Gift Tax Exclusion and 529 Plans. The annual gift tax exclusion is $11,000 for 2004. Note that for Section 529 Qualified Tuition Programs, you are allowed to front load your contributions by electing to spread the gift over five years for gift tax purposes. Therefore, in 2004 you can transfer up to $55,000 to a Section 529 plan for each designated beneficiary without incurring a gift tax liability ($110,000 if a gift-splitting election is made by a husband and wife), assuming no other 2004 gifts to that beneficiary.

Capital Gains Tax Rates. It may be a good time to consider selling appreciated stock. The 2003 Tax Act reduced the capital gains tax rates to a maximum of 15% on gains from the sale of qualifying assets (e.g., common stock) held more than one year. The lower rates are available for both regular and alternative minimum tax (AMT). In addition, qualifying dividends individuals receive during 2004 will be taxed at the capital gains rates.

Elective Deferrals. The 2004 annual deferral limit for qualified retirement plans [e.g., 401(k) plans] is $13,000. If you are at least age 50 by year-end, you can contribute an additional $3,000 to 401(k), 403(b), and 457 plans in 2004. Planning ahead for next year, the 2005 annual deferral limit for these plans is $14,000. If you are at least age 50 by year-end, you can contribute an additional $4,000 to 401(k), 403(b), and 457 plans in 2005.

The Check 21 Act Streamlines Check Processing

The Check Clearing for the 21st Century Act (Check 21 Act) was signed into law on October 28, 2003, and is effective on October 28, 2004. The Check 21 Act is designed to eliminate some of the legal impediments to check truncation (cut-off or stop the return of cancelled checks) and foster innovation in the banking industry's check payment system. The Check 21 Act offers a new negotiable instrument called a "substitute check" to facilitate check truncation and electronic check exchange. A substitute check is a paper reproduction of the original check and can be processed just like the original check. The substitute check contains an image of the front and back of the original check.

For consumers, the first thing you will notice is that you can no longer receive your original cancelled checks. You may be able to get substitute checks, but no originals will be returned. Your checks will clear sooner (electronically), increasing the risk of a bounced check if the funds are not in your account when you write the check… no more float. However, the Check 21 Act does not shorten check hold times for deposits, so you probably won't get access to your funds any sooner.

IRS Releases IRA Statistics

For the first time, recently released statistical information from the IRS contained detailed information on IRAs. The information from 2000 (the latest available) indicated that 46.3 million taxpayers held IRA accounts worth a total of

$2.6 trillion in fair market value. Over $2.4 trillion was invested in traditional IRA plans, which have been available for the longest time. Of the remaining amount, $134 billion was invested in Simplified Employee Pension (SEP) plans, $77.6 billion in Roth IRAs, $10.4 billion in Savings Incentive Match Plans for Employees (SIMPLE) plans, and $300 million in Education IRAs (now called Education Savings Accounts). In 2000, 15.1 million taxpayers contributed to an IRA.

Interesting Websites for Teleworkers

Many of us currently work from a home office or, at least occasionally, telecommute. ChiefHomeOfficer.com at www.chiefhomeofficer.com provides tips and information for small business owners and teleworkers as well as companies that serve them. This website also provides links to other websites with information on working at home, small business, technology, privacy rights, and other helpful resources.

YouCanWorkFromAnywhere.com at www.youcanworkfromanywhere.com provides a free monthly email newsletter, articles, e-books, and links to other informative websites. This website also offers information on teleworking in general, technology for mobile workers, setting up a home office, and balancing your work and personal lives.

Deciding When to Start Receiving Social Security Benefits

If retirement is on your radar screen, you may need to consider whether to begin taking reduced Social Security benefits (as early as age 62) or wait until your full retirement age. For some, this decision hinges on nonfinancial factors - the enjoyment they receive from working, for instance. For others, it is strictly a matter of dollars and cents.

Even if they have sufficient retirement funds without Social Security, some prefer to begin receiving benefits ASAE. These potential retirees reason that they will receive more benefits checks over the course of their lifetime this way. Truth is, according to the SSA's online calculators, it will take 10-12 years (depending on your income level) to reach the break-even point.., the point in time after which waiting pays off. Thus you may only have to live until age 76 or 77 to benefit from waiting until your full retirement age to take benefits.

Those who can afford to wait might carefully consider these advantages:

A significant element in planning your retirement is the length of the retirement period. This is determined by subtracting your age at retirement from your life expectancy. By working past age 62, you are shortening your retirement period and decreasing the resources needed to fund your retirement.

Early Social Security benefits may come at a cost if you intend to keep working. Social Security benefits are reduced $1 for every $2 in earnings above the exempt amount ($11,640 for 2004).

Your Social Security benefits are based on your primary insurance amount (PIA), which is calculated from your highest earnings during a 35-year period. If you can replace lower-wage years early in your career with higher wage years after age 62, you can increase your PIA. This can lead to a dramatically higher retirement benefit.

Social Security benefits receive an annual inflation adjustment. By taking early benefits, you will receive a smaller annual dollar increase and will miss out on the compounding effect of that increase. In effect, the gap between your early retirement benefit and the amount you would have received by waiting will get bigger and bigger.

Receiving Social Security benefits before reaching your full retirement age may also affect your spouse's benefits. Unless your spouse has his or her own earnings record and is fully insured, he or she will be dependent on your PIA for retirement benefits. If your early retirement results in a lower PIA, your spouse's benefit may be smaller also.

Your life expectancy may be the biggest factor in deciding whether to receive benefits early. While tables and averages are available, you should have a good handle on your own life expectancy. Your current health and your parents' longevity should be clearly established by now. In general, if you reasonably expect to reach age 80, waiting until the full retirement age may be a wise choice.

Note: While you may have the option of retiring early, the Medicare eligibility age remains at 65.

IRS Cracks Down on Nonprofits and Charitable Contributions

The IRS is focusing on abuses in tax-exempt organizations that fall into two broad categories: internal abuses and the misuse of tax-exempt entities by third parties. The IRS perceives internal abuses to be largely attributable to failures in governance.

The IRS is concerned that governing boards aren't following appropriate guidelines or exercising sufficient diligence in setting compensation for key employees resulting in unreasonably large compensation packages for executives of public charities and private foundations. The Service is launching a comprehensive enforcement project to examine compensation issues (mostly via correspondence rather than field audits). In addition to the excessive compensation issue, the IRS is obviously concerned about terrorist financing by U.S. charities. A third area of concern is credit counseling organizations that have been granted tax-exempt status, but, in reality, aren't functioning as charitable organizations.

In addition to internal abuses, the IRS has uncovered a disturbing variety of ways that outside persons are exploiting a nonprofit organization's tax-exempt status. These third party abuses aren't necessarily detrimental to the nonprofit organization, but are detrimental to the overall income tax system. Aggressive tax shelters have been devised to use the tax-exempt (nonprofit) organization as an "accommodation party." These strategies typically provide only a small economic benefit to the exempt organization, but generate substantial tax savings for an outside party that is a taxable entity. They are intricately structured and generally lacking in economic substance and real business purpose. For obvious reasons, the IRS wants to get tax exempt organizations out of the tax shelter business.

In addition to aggressive tax shelters, the IRS believes there is a consistent pattern of abuse relating to property donations. The overvaluation of charitable property gifts, both intangible (e.g., patents) and tangible (e.g., autos), is an issue of major concern to the IRS. The abuse occurs when the overvalued property is gifted to a nonprofit and a subsequent inflated charitable contribution deduction is taken on the donor's tax return. In addition, the IRS has uncovered numerous cases where donors have received consideration in return for their donation, but still claimed the full charitable deduction on their tax return.