Volume 27 Number 3, Summer 2006
Start Planning Now to Take Advantage of New Tax
Cuts
Tax Benefits in Telecommuting
Should I Worry About the Tax Gap?
The Better Way
Pennsylvania's Minimum Wage to Increase in 2007
Start Planning Now to Take Advantage of New
Tax Cuts
The
new $70 billion tax cut package signed into
law by President Bush on May 17 extends some valuable tax breaks that you
need to know about. Under the new Tax Increase Prevention and
Reconciliation Act, you can take advantage of reduced tax rates on
dividends and capital gains, enhanced treatment of Roth IRAs, some
incentives to lower your AMT liability, increased small business
expensing, and many other incentives.
Don't let the "2005" in the title of the new law confuse you. The tax
incentives in the new law are important in 2006 and in future years.
"Kiddie" tax. The new law makes
a huge change to the "kiddie" tax rules. We addressed some of these important
changes in our Spring 2006 issue of the Quarterly Review. Please
refer to the front page article or contact one of our offices so we can help
you evaluate your savings strategy.
Dividends and capital gains.
Three years ago, Congress lowered the maximum dividend and capital gains tax
rate for most -- but not all -- dividends and capital gains. The tax on
qualifying dividends fell from a high of 35 percent (depending on income tax
bracket) to 15 percent. The tax on qualifying capital gains tax rates fell
from 20 to 15 percent. Congress also created a special, lower dividend tax
rate of five percent for taxpayers in the 15 and 10 percent brackets. They are
eligible for an even lower tax rate of zero percent in 2008.
When the dividend and capital gains tax rate cuts were enacted in 2003,
they were intended to be temporary. The rates were going to expire on December
31, 2008.
Last year, the White House began lobbying hard for Congress to extend the
dividend and capital gains tax rate cuts beyond 2008. Many Republicans agreed
but Democrats were very opposed to the extension, which they viewed as
premature. They proposed to wait until 2008 and then decide whether to extend
the tax cuts. Republicans control both the House and the Senate, and even
though their majorities are slim, they had enough votes to extend the dividend
and capital gains now rather than waiting until 2008.
Because of the extension, investors can take a significantly longer view on
long-term investments. Many investors were anticipating having to act before
December 31, 2008 to take advantage of the lower rates. Now, you have two more
years to potentially maximize your tax savings.
Roth IRAs. For many years,
higher-income individuals could not convert traditional IRAs to Roth IRAs. The
new law changes this treatment. In 2010 and beyond, taxpayers with adjusted
gross incomes above $100,000 will be allowed to convert traditional IRAs to
Roth IRAs.
Even though this tax break is not available until 2010, it's not too early
to be thinking about a Roth IRA conversion plan. You may want to consider
rolling over 401(k) balances to IRAs when leaving employment, investing in
traditional IRAs in anticipation of conversion to Roth IRAs. These are just
two of many options you may have under the new tax law. Give us a call and
we'll craft a Roth IRA conversion plan that is tailored to your needs.
Temporary AMT relief. More than
30 years ago, Congress created the alternative minimum tax (AMT) to combat tax
evasion by a handful of extremely wealthy people. Congress did not index the
AMT for inflation. Inflation has so eroded the value of the dollar over the
past 30 years that the AMT now applies to millions of middle-income taxpayers.
Congress could "fix" the AMT so that it once again applies only to the very
wealthy. It hasn't. Although many politicians on Capitol Hill are hearing from
their constituents that they want the AMT abolished, the AMT brings in huge
amounts of revenue. Getting rid of it would cost the federal government
hundreds of billions of dollars in lost revenue.
Instead, Congress has sought to soften the blow of the AMT by giving
taxpayers some breaks. The new law slightly increases the AMT exemption
amounts and also allows taxpayers to use the nonrefundable personal credits to
offset regular and AMT liability. This special treatment is effective for 2006
only.
Small business expensing.
Businesses usually prefer to expense rather than capitalize business
investments. In 2003, Congress raised the amount of annual investment that
small businesses may elect to deduct from $25,000 to $100,000. The $100,000
threshold is reduced by the amount by which the cost of qualifying property
exceeds $400,000. The $100,000 and $400,000 amounts are also indexed for
inflation. For 2006, they are $108,000 and $430,000.
Again, the enhanced small business expensing amounts were temporary. They
were scheduled to expire on December 31, 2007. The new law extends them for
two more years through December 31, 2009.
Because the higher amounts were originally set to expire at the end of next
year, you may have been trying to shoehorn purchases into an accelerated
schedule. The new law gives you more time to consider when to make these
purchases and how to maximize your tax savings.
Like every new tax law, the details are important. You may be eligible for
some significant tax savings. Don't hesitate to contact our office so together
we can review your tax situation and put together a plan that may help lower
your tax bill .
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Tax Benefits in
Telecommuting
If you're
thinking about setting up employees as telecommuters, you're not alone.
Businesses ranging from large multi-nationals to small shops know that
telecommuting not only can improve worker morale and performance, it can
also save you and your employees money. What's not to like about zero
commuting costs and no office rent? You can also sell the benefits of
telecommuting by alerting employees to some significant tax breaks.
Your federal tax responsibility.
As the employer, your federal tax responsibilities will not change because one
or all of your employees telecommute. You'll withhold federal payroll and
income taxes from their paychecks just as before. Some states and local
jurisdictions, however, are trying to capitalize on the telecommuting trend by
demanding withholding taxes based on the location of the telecommuter rather
than that of a business's regular office. Check with our office to see if this
applies to you.
Tax savings for employees.
Telecommuting can open the door to some tax savings for your employees.
However, and this is very important, the IRS looks very carefully for abuses,
especially inflated home office deductions. You'll want to spell things out
very clearly when you set up an employee in a home office.
The home office must meet some tough IRS tests to qualify for the
deduction. It must be used for the convenience of the employer and used
regularly -- and exclusively -- as a principal place of business or a place
where the taxpayer meets or deals with patients, clients or customers.
Additionally, the employee must not rent any part of his or her home to the
employer.
If you decide that an employee should telecommute, your decision satisfies
the "at the convenience of the employer" test. However, if an employee asks
you if he or she can work from home, that request likely would not satisfy the
test. An employee's preference to work from home would not meet the IRS's
criteria.
Telecommuters who work exclusively from home should not have difficulty
satisfying the "principal place of business" test. Their home office is where
they work for you 100 percent of the time. However, taking depreciation
deductions on a home office may not provide a significant tax savings since
those deductions reduce your tax basis in your home and therefore raise the
amount of gain potentially taxable on its eventual sale. The $250,000
exclusion of taxable gain from the sale of a principal residence ($500,000 in
the case of a joint return) may not be used to shelter any gain attributable
to the business-use of your residence. That may point to foregoing the home
office deduction even if the employee may be entitled to it.
Your employee may not work from home all the time. For example, he or she
may work at home three out of five days. If you're thinking about this type of
telecommuting arrangement, contact our office for more details. We'll help you
and your employees avoid any potential mishaps with the IRS.
Home office supplies. A home
office needs supplies just like in the employer's workplace. Items you supply,
such as furniture, computers, scanners, fax machines, stationery, telephones,
are deductible by you as the employer. They get the same tax treatment just as
if you provided them in your workplace. This is regardless of whether a
portion of the home itself qualifies for the home office deduction.
You may want to reimburse your telecommuters for utility charges, telephone
calls and similar expenses. Generally, these amounts will not be considered
income to the employee. They could also be treated as tax-free working
condition fringe benefits.
Just like the rules for deducting a home office, deductions for supplies
can get complicated. Again, let us help you put together a helpful
telecommuting plan that not only maximizes tax savings for you and your
employees but, most importantly, does not raise any red flags for the IRS.
Transportation costs.
Transportation costs from a home office to another place of business may be
either a deductible transportation expense or a nondeductible commuting
expense. It depends on which location is the individual's principal place of
business. This area is fraught with potential traps. The IRS and the courts
have made some very technical and fine distinctions. We can help you
understand them and set up a transportation policy that meets your needs.
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Should I Worry About the Tax
Gap?
The
IRS is taking a very close, and somewhat controversial, look at small
businesses to close the tax gap. The tax gap is the difference between what
taxpayers owe and what they actually pay. The IRS estimates it to be around
$325 billion.
Small businesses are being targeted because data from a recent study
indicates that small businesses and self-employed individuals are the largest
contributors to the tax gap at 43% of under-reported income.
To bring more small businesses in compliance, the IRS recently launched a
new education campaign. It recently released the first in a series of "Fact
Sheets." This campaign is designed to give small business owners fair warning
of the rules. The next step for the IRS will be to come down hard on the
offenders.
Basic requirements. The IRS is
reminding small businesses of some basic fundamental principles of taxation.
Small business owners and self-employed taxpayers must report all income
received by their businesses, unless there is a specific exclusion provided by
the law. If there is a connection between any income received and a business,
then it is business income. The connection is if the payment of income would
not have been made if the business did not exist and operate.
Business income will probably be received in the form of cash, checks and
credit card charges. Additionally, any payments of income that are directed to
a third party do not remove the requirement to report the income. Business
income can also include bartering, real estate rents, interest and dividend
income, cancelled debt and damages.
The first Fact Sheet also explains how to calculate a business's cost of
goods sold and how to calculate their gross income. The IRS plans to release
another Fact Sheet for small business owners on overstated business expenses,
a significant factor contributing to underreported income.
Useful tools for small business owners.
The IRS recommends setting up a formal set of books and records with strong
internal controls. Additionally, small businesses should look into accounting
or financial computer software to ease the burden of computations. SEK&Co has
individuals who are certified QuickBooks ProAdvisors to help set up and train
you in these popular software programs. Most importantly, small businesses and
their owners should separate their bank accounts into business and personal to
avoid confusion between the income and expenses in the two accounts.
Congress wants action on tax gap.
Congress has also become involved in the fight against noncompliance. The
Senate Finance Committee and the House Ways and Means Committee have held
hearings on what the IRS is doing to close the tax gap.
While Congress wants the IRS to crack down on tax evasion, some lawmakers
are concerned that the agency is focusing too much on small businesses and not
enough on large corporations.
IRS Commissioner Mark Everson has told Congress that the agency is not just
targeting the "little guy" and is combating tax evasion across-the-board.
White House proposals. The
White House has also suggested several measures to curb tax evasion by small
businesses. One of the proposals would require issuers of credit and debit
cards to report reimbursements made to merchants. If the card issuer has no
taxpayer identification number on file for that merchant, the issuer would be
required to withhold taxes on payments to that merchant.
Congress has not acted on this or other White House proposals yet.
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The Better Way
Hi Bracket's son, Junior, owned a
condo at the beach which he rented and used personally for his vacation.
With gas prices being so high, people weren't traveling as much so his
condo didn't rent for all the weeks he had hoped. Not to fear - Junior
decided to take additional time off (he worked for his father, you know)
and use it himself. What a great summer!
When his tax return was done, he owed more tax than the prior year and it
was due to the condo. His expenses were the same and rental income was down.
That should mean a larger loss than last year but there was no loss at all.
How could this be?
When vacation property is used for 14 or less days personally, it is
prorated into two properties, one personal (no deductions allowed) and one
rental where a rental loss may be allowed based on your other income. When you
go over 14 days usage, the property is part "second home" (with prorated
mortgage interest allowed) and part "vacation home" where expenses can only
offset income having a zero loss for a write-off. Junior had crossed the line
and the nature of his condo changed.
If you have or are thinking about buying such property it would be good to
get a feel for "passive loss" and "vacation home" rules. We will be glad to
help you plan -- how much and how you use the property can make a big tax
difference!
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Pennsylvania's Minimum
Wage to Increase in 2007
Governor
Ed Rendell has signed legislation to increase the minimum wage in
Pennsylvania. The law increases the minimum wage to $6.25 an hour on
January 1, 2007, and to $7.15 an hour on July 1, 2007.
Employers with 10 or fewer full-time employees will follow a delayed
implementation schedule, increasing the minimum wage to $5.65 on Jan. 1, 2007;
$6.65 on July 1, 2007 and $7.15 on July 1, 2008.
The new law also provides for a 60-day training wage, based on the federal
$5.15-per-hour training wage, for employees under 20 years of age. Upon
hiring, employers must notify workers of both the training wage and the
workers’ right to receive the Pennsylvania minimum wage after 60 calendar days
of employment. The law also makes it clear that other workers may not be
displaced to allow hiring of training-wage workers.
The last time Pennsylvania’s General Assembly increased the minimum wage
was in 1988.
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