November 1999

Special Tax Issue


Year-End Tax Planning for Individuals
Deductible Expenses for the Small Business
Taxpayer Victory: IRS's Position Not "Substantially Justified"
Tax Calendar

Year-End Tax Planning for Individuals

Tax planning is something most people don't want to take time to do, especially during the busy fall season. But a few moments of planning now can make a big difference on your tax bill next April.

Capital gains and losses

Stock market investments can have significant tax consequences. Knowing the tax rules may affect your investment strategies and help you make informed decisions.

Timing. Be aware of the impact the timing of capital gains may have in other areas. Capital gains are fully included for determining the adjusted gross income (AGI) amount, even though it is only taxed at a maximum 20% rate. AGI is used to measure whether a taxpayer is eligible for such tax benefits as the child credit, Roth IRA contributions and rollovers, and education incentives.

Use the capital gains rate to your advantage. Try to only sell shares you've held for more than 12 months. That way you'll qualify for the more favorable long-term 20% capital gains tax rate (10% for taxpayers in the 15% tax bracket).

Use your losses in two ways. If your investments saw considerable gains in 1999, search your portfolio for offsetting losses. Conversely, if you expect high losses next year, try to postpone realizing gains until then. In addition, you're allowed to write off losses dollar for dollar against your gains plus $3,000 of ordinary income. If you have no gains, you can still deduct the losses against up to $3,000 of ordinary income.

Generate a loss, then repurchase a stock. If you think your depressed fund or stock will bounce back, but you'd still like to generate a taxable loss, you can sell it and then buy it back. But make sure you wait more than 30 days after the date of sale before you buy it back. If you buy or sell identical securities prior to this period (30 days before or 30 days after the date of sale), the so-called "wash-sale rule" won't let you take a loss.

Don't buy mutual funds at the end of the year. Fund companies usually distribute all their capital gains and dividends at year-end, and you'll be taxed on the payout without enjoying any increase in the value of your investment.

Miscellaneous expenses

Miscellaneous expenses are deductible only to the extent that they surpass 2% of your AGI. Expenses that qualify as miscellaneous generally fall into one of three categories: employment or business, investment, or tax. If your miscellaneous expenses are near the 2% limit, try to bunch them into alternate years to increase your deduction. To bulk up, consider investing in job-related equipment and training. Other options include paying next year's professional dues, subscriptions, and investment management fees in late 1999.

Charitable contributions

As long as you itemize, charitable donations remain fully deductible, but there are deduction ceilings for very substantial contributions. For cash contributions, the deduction ceiling is generally 50% of your AGI. For appreciated property donations, the deduction limit is generally 30% of AGI. Make sure you have a contemporaneous written receipt from the charity for single donations of $250 or more. A canceled check is not sufficient proof for tax purposes.

If you donate securities held for more than 12 months, not only will you reduce your taxable income, but you can take a deduction for the fully appreciated market value of the stock and also avoid capital gains tax on the sale.

Education credits

Lifetime Learning Credit. This credit allows you to claim 20% of the first $5,000 in education expenses (a $1,000 maximum credit). It applies to fees incurred by a qualified dependent, your spouse, or yourself to attend an accredited college, university, or vocational school leading to a bachelor's degree, an associate's degree, or another recognized post-secondary credential. The Lifetime Learning Credit is phased out for taxpayers with modified AGI between $40,000 and $50,000 (between $80,000 and $100,000 for joint filers).

Hope Scholarship Credit. You're allowed a credit of up to $1,500 (100% of the first $1,000 in tuition, 50% of the second $1,000 in tuition) for your dependent children who are students, but the credit applies only to a student's first two years of post-secondary education. The Hope Scholarship Credit is subject to the same phase-outs as the Lifetime Learning Credit.

Education IRA. Eligibility for education IRAs phases out for single taxpayers with modified AGI between $95,000$110,000, and between $150,000$160,000 for joint returns. If you qualify, earnings accumulate tax-free and there will be no tax on withdrawal if the money is used for qualified education expenses. If the money in an Education IRA is not used (or is not rolled over into another education IRA) by the time the child is 30, the beneficiary will be taxed on the earnings and will owe a 10% tax penalty.

Note: The Hope Scholarship Credit, the Lifetime Learning Credit, as well as tax-free withdrawals from Education IRAs, are mutually exclusive. You can elect to use only one of them.

To fully take advantage of the Hope and Lifetime Learning Credits, some postponing or accelerating of tuition payments is often needed. If parents are over the AGI level allowed for taking the Lifetime Learning Credit, they might consider having the student take the credit. This requires that the student not be claimed by the parent as an exemption.

IRAs and other accounts

Plan to make maximum contributions to your Individual Retirement Account (IRA). Even if you can't deduct your contributions, IRAs might still make tax sense since earnings grow, tax-deferred, until withdrawn.

Roth IRAs. Withdrawals of the contributions and earnings are tax free, as long as the account has been open for at least five years and you have reached age 591/2, or on or after death or disability. In addition, contributions may be made after you reach age 701/2 and you can leave amounts in your Roth IRA as long as you live. A rollover to a Roth IRA is attractive if you expect to be in the same or higher tax bracket in retirement. A rollover is not as attractive if you will be in a substantially lower tax bracket at retirement and if you lack the funds to pay the tax resulting from the conversion.

Note: If you convert your traditional IRAs into a Roth IRA in 1999, you'll pay tax on the conversion income in 1999. There is no option to spread the income over four years as in 1998.

Medical expenses

Since only medical expenses that surpass 7.5% of your AGI are deductible, be sure to total them before year-end to see if you are near the limit. If you are, accelerate elective medical procedures into this year to increase your deduction. Otherwise, postpone any non-essential medical expenses until next year. When making your calculation, don't forget to include doctor bills, prescriptions, insurance premiums, and transportation costs to and from medical facilities. Many other expenses qualify, such as eyeglasses, wheelchairs, contact lenses, braces, orthopedic shoes, and hearing aids.

Adjust withholding

Before the end of the year, match your withholding to your estimated tax liability. If you've moved up to a higher tax bracket, adjust your withholding or you may be hit with an underpayment penalty. Conversely, you may be giving the IRS more than you need to; if you received a tax refund last year, you may want to adjust your withholding and invest the extra cash.

Other tips

Put off that bonus. Ask your employer to defer paying your year-end bonus until after the first of the year.

Accelerate itemized deductions not subject to income thresholds. Make your January 2000 mortgage payment or home equity loan payment in late 1999. Pay state or local taxes early by making your January 2000 estimated tax payments in late 1999. Increase your state or local tax withholding for the rest of the year.

If you have any tax-planning questions, please contact our office.

Deductible Expenses for the Small Business

If you're not entirely clear on what constitutes a deductible business expense, you're not alone. Many business owners are unsure about what they can and cannot deduct. To use the IRS's terms, almost any "ordinary and necessary" expense that is "reasonable and customary" qualifies as a deductible business expense. The words reasonable and customary refer to your specific business and the business customs in your area. For example, if you're in the advertising business, you may be able to deduct just about every newspaper and magazine you buy because an awareness of trends in advertising is central to your business. The same deduction would not be available to you if you have a catering business.

Current versus capital expenses

Before discussing specific deductions, you need to know the difference between current expenses and capital expenses that must be depreciated. Current expenses, which include the everyday costs of keeping your business going, such as office supplies, rent, and electricity, can be deducted in the year you incurred them. But expenditures for things that will generate revenue in future years (a desk, a copier machine, or a car, must be depreciated) that is, written off over their useful life. According to IRS rules, that period is usually three, five, or seven years.

There is an important exception to this rule (the expensing deduction, a special tax break for smaller businesses. Under Section 179 of the Tax Code, in 1999, you can immediately write off up to $19,000 in equipment purchases, rather than depreciating their cost over a period of years. In addition, the equipment purchases are eligible for a full write-off under the expensing method no matter how late in the year the purchases are made. If you charge the purchase on a credit card before the end of the year and do not get billed until January, you can still take the deduction in 1999, as long as you placed the asset in service before the end of the year.

Expensing gives you an immediate deduction, but there are a few rules you need to know. The amount you can write off immediately is limited to the amount of taxable income you have from your business. Special restrictions also apply to personal computers, cellular phones and certain other equipment. Generally, these items must be used more than 50% of the time for business in order to qualify for expensing.

As a general rule, it's a good idea to place new equipment into service before the end of the year. Under the "mid-year convention," business assets placed in service during the latter half of the year are treated as if they had been placed in service on July 1 for purposes of computing depreciation deductions. In other words, you may be able to claim the equivalent of a half-year's worth of depreciation (even if you use the equipment only for a few days in December. However, a special tax rule is triggered if you place too much equipment in service at year-end. Specifically, if the cost of business assets placed in service during the last quarter of 1999 exceeds 40% of the cost of all business assets put in service during the year, your depreciation deductions for all assets placed in service during the year are figured under the mid-quarter convention, which will dramatically reduce your annual depreciation deduction.

Charitable contributions

Businesses may contribute cash or property to charities. Unincorporated business owners may make and fully deduct cash gifts of up to 50% of adjusted gross income and may contribute appreciated property of up to 30% of adjusted gross income. Unless your business is a C corporation, you deduct charitable contributions by the business on Schedule A of your

personal tax return. A corporation may deduct on its corporate return

charitable contributions that total no more than 10% of the corporation's modified taxable income. A considerable tax advantage exists for business owners who donate property that has appreciated in value. In addition to a deduction for the full market value of the property, the donor avoids tax on the appreciation that has built up.

Transportation expenses

If you use your personal car for business, or your business owns its own vehicle, you can deduct some of the costs connected with keeping your car running. There are two methods of claiming automobile expenses. You can either keep track of and deduct all your actual business-related car expenses, including gas and oil, repairs and maintenance, depreciation, insurance, tires, or you can simply take the standard mileage rate. This rate is set by the IRS and is adjusted annually. For 1999, the standard mileage rate was lowered, effective April 1, to 31 cents for each business mile driven. If you're not sure which method to use, as a general rule, if you have a newer car and you use it primarily for business, the actual expense method is likely to provide a larger deduction.

When you travel for business, you can deduct many expenses, including the cost of plane fare, taxis, lodging, meals, and telephone calls, etc. If you extend your stay to take advantage of the "Saturday overnight requirement" for discounted airfare, your hotel room and meals would be deductible.

Entertainment expenses

As a business owner, if you entertain clients or customers, you can deduct 50% of your qualifying business meal and entertainment expenses. Entertaining guests at restaurants, nightclubs, theatres, sporting events ( any activity considered to provide entertainment, amusement, or recreation (falls into this category. Meal and entertainment expenses qualify for a deduction if they meet at least one of two tests. The entertainment must be "directly related" to the active conduct of your business, which means business is the primary purpose of the meal or entertainment expense, or it must be "associated with" business, which means even if you don't discuss business at the meal, the meal or entertainment expense precedes or follows a substantial business discussion. For example, catering lunch for a business meeting would be a "directly related" expense, while meeting a client to discuss a proposal and then taking him or her to a ball game would fit the "associated with" requirement.

Note: Holiday parties, picnics and other social events you put on for your employees and their families are an exception to the 50% rule; such events are 100% deductible.

If you give gifts to clients in the course of your business, especially during the year-end holiday season, you can deduct up to and including $25 for business gifts you give to any one person during the tax year. Any amount in excess of $25 is disallowed as a deduction. The $25 limit doesn't include shipping or engraving.

Bad debts and casualty losses

If a customer or vendor doesn't pay your invoice, that bad debt may or may not be deductible; it depends on what you're billing for. If your business sells goods, you typically can deduct the cost of goods you sell but don't get paid for. But before you can claim a bad debt write-off, the IRS requires that you take reasonable steps to collect payment. That can include giving the debtor written warnings or going to a collection agency or small-claims court. Since a bad debt deduction can only be taken in the year in which the debt becomes totally worthless, you should step up your collection efforts if you have some bad debts you want to write off this year.

Unfortunately, if your business provides a service such as writing or consulting, you cannot deduct an unpaid bill as a bad debt. No tax deduction is allowed for time you devoted to a client who doesn't pay. The rationale behind the rule is that it would be too easy for businesses to inflate bills and claim large deductions for bad debts.

As many small business owners have learned during the past few years, hurricanes, floods, tornadoes and blizzards can do severe damage to business property. If your business property is damaged or destroyed due to some unforeseen event such as one of these, you may be entitled to deduct the loss. A special rule applies to business property that is completely destroyed as a result of a casualty loss. In such cases, your loss is your basis in the property without regard to fair market value. There are no dollar limitations on these losses as there are on personal losses, nor are there any adjusted gross income limitations. You must, however, reduce your loss by the amount of any insurance reimbursement you receive.

Home office deduction

As of January 1, 1999, the home office deduction rules became more lenient. The Taxpayer Relief Act of 1997 made the home office deduction more accessible by expanding the definition of "principal place of business." The new definition benefits those self-employed persons who manage a business from their homes, but also provide a service or meet clients at another location. An example would be a doctor who sees patients at local clinics, but conducts the administration or management activities of the business from a home office. A home office now qualifies as your principal place of business if you use it regularly and exclusively to conduct the administrative or management activities of a business and there is no other fixed location where you conduct substantial administrative or management activities.

Health insurance deduction

If you are self-employed, for 1999, you are eligible to deduct 60% of the cost of health insurance to cover you, your spouse, and your dependents. This above-the-line deduction is available whether or not you itemize. Assuming you itemize, you can add the remaining 40% of what you pay for health insurance to your medical expenses. If the total of your itemized medical expenses exceeds 7.5% of your adjusted gross income (AGI), all your medical expenses become tax deductible.

Expenses of going into business

The cost of investigating the potential for a new business and getting that business started are capital expenses, which can be recovered by depreciation or amortization. Under tax law, you may elect to depreciate or amortize your start-up costs over a period of 60 months or more if two conditions are met: (1) those costs would be deductible if they were paid or incurred to operate an existing business and, (2) the costs were paid or incurred before you actually began business operations. If you decide not to go into business, any costs you paid to investigate the possibility of going into business are considered personal costs and are not deductible. Costs you paid in your attempt to actually start or purchase a specific business can be claimed as a capital loss.

Medical Savings Accounts

Medical Savings Accounts (MSAs) are designed to work in conjunction with high-deductible health insurance plans and are available to self-employed individuals and owners and employees of small businesses. MSAs are similar to IRAs in the sense that employers and employees can make tax-free contributions to the MSA. Instead of withdrawing the funds at retirement, the taxpayer withdraws the funds to pay for qualified medical expenses. Assets not spent on medical expenses accumulate from year to year and can remain invested on a tax-deferred basis to fund future medical expenses or to supplement the taxpayer's retirement savings.

Obsolete inventory

Goods that cannot be sold at normal selling prices or in the usual way because of changes of style or damage may be valued for deduction purposes at bona fide selling prices, less the direct costs of disposition. To realize expected losses, take steps to dispose of obsolete inventory.

Miscellaneous expenses

If you're like many small business owners, you regularly spend small amounts of cash on things like pens, taxis, and postage stamps. While these may not seem like large outlays at the time, over the course of a year, they can add up. For example, suppose you stock your office lunchroom with coffee, soft drinks, and snacks. That $25-a-month outlay translates into a $300 expense over the course of a year and it is all deductible. One way to improve your cash expense record keeping is to reimburse yourself by check. Every few weeks, tally your cash receipts and write yourself a business check for the amount you spent. You don't necessarily need a receipt for items under $75; just be sure to keep good records. One way to do so is to put all of your small business purchases on a corporate charge card that provides you with regular management reports. This will save you time and money during tax preparation time.

IRS studies show that poor records, not dishonesty, cause most small business people to lose at audits or fail to comply with their tax reporting obligations. It's important to keep detailed records of expenses for travel away from home, business meals and entertainment, business gifts, automobile expenses and others.

Taxpayer Victory: IRS's Position Not "Substantially Justified"

In October 1994, the taxpayers were telephoned by an IRS agent in the El Paso, Texas office, who indicated there would be an examination of the taxpayers' 1991 and 1992 tax returns. In November 1994, the taxpayers' representative wrote the IRS agent, asking that the location of the examination be held in Dallas, as all the taxpayers' records, books, and source documents for 1991 and 1992 were at that office. The IRS had not stated what specific matters were to be addressed in the examination. Because of the transfer, the IRS asked the taxpayers to consent to extending the period of limitations for the 1991 income tax year to June 30, 1996. The extension was made for 1991, but the 1992 limitations date remained the same.

The files were transferred to the Dallas office, 161/2 months before the limitations period for 1991 would have expired, but the case was not assigned to an IRS agent until 101/2 weeks before the limitations period expiration. The agent then called the taxpayers' representative and asked for extensions of the limitations period, but the taxpayers' representative expressed reluctance because he had already consented to one extension. At the meeting, the taxpayers responded to the agent's questions for two hours. Two days later, the agent prepared Form 872 to extend the limitations period and tried contacting the taxpayers' representative via telephone for the next two weeks. The agent went to the taxpayers' representative's office with the Form 872. The representative refused to sign the Form 872, stating that he was willing to consent to an extension of the limitations period if the agent was willing to limit the scope of her examination. The agent refused to agree to this without speaking with her manager. Also at this meeting, the representative noted that he had never received an Information Document Request (IDR) for the years in question. She offered to give to him the IDR that she had prepared for the April 23 meeting, but he refused to accept it.

The next day the IRS issued a notice of deficiency for the 1991 and 1992 tax returns. The taxpayers then filed a petition with the Tax Court.

Result: The Tax Court agreed with the taxpayers, and found that the IRS had made no attempt to obtain information and had failed to diligently investigate the case. The court also stated that the taxpayers were not blameless (their representative could have asked for an IDR or other listing of documents that the IRS needed, but did not do so. The representative should have returned the agent's phone calls, but the only indication in the record as to the purpose of these calls was that that agent wanted a limitations extension and not substantiation materials. But the court found the IRS agent could and should have served an IDR at the meeting. Instead, she withheld the already prepared IDR and did not otherwise ask for any substantiation at the meeting. Because the IRS had "frittered away" the bulk of the extension already granted by the taxpayers, the IRS was then required to take its position in this case. At the time of the IRS's answer to the Tax Court petition, it did not have any substantiation, because it had not asked for it. The court concluded: "Thus, the (IRS) created the very problem that the IRS seeks to use as an excuse," and held for the taxpayers. Maddox v. Commissioner, T.C. Memo 1998-449.

Tax Calendar

  • November 1

Employers. For Social Security, Medicare, and withheld income tax, file Form 941 for the third quarter of 1999. Deposit any un-deposited tax. If the total is less than $1,000 and not a shortfall, you can pay it with the return. If you have deposited the tax for the quarter in full and on time, you have until November 10 to file the return.

For federal unemployment tax, deposit the tax owed through September if it is more than $100.

Employees who work for tips. If you received $20 or more in tips during October, report them to your employer. You can use Form 4070.

  • November 10

Employers. For Social Security, Medicare, and withheld income tax, file Form 941 for the third quarter of 1999. This due date applies only if you deposited the tax for the quarter in full and on time.

  • November 15

Employers. For Social Security, Medicare, withheld income tax, and non-payroll withholding, deposit the tax for payments in October if the monthly deposit rule applies.

  • December 10

Employees who work for tips. If you received $20 or more in tips during November, report them to your employer. You can use Form 4070.

  • December 15

Employers. For Social Security, Medicare, withheld income tax, and non-payroll withholding, deposit the tax for payments in November if the monthly deposit rule applies.

Corporations. Deposit the fourth installment of estimated income tax for 1999. A worksheet, Form 1120-W, is available to help you make an estimate of your tax for the year.

Site Map - Services - Calculators - Bulletin - Affiliations - Home