If an elderly taxpayer has surplus assets and a source of retirement income, why not give away the surplus assets now, to avoid some or all the estate tax that may result later??  Many older folks are single and, if well provided-for by parents or a deceased spouse, some income tax savings can result by transferring wealth to younger beneficiaries who benefit from the lower tax paid by married couples.  And certainly future appreciation of real estate or portfolio assets can avoid exposure to future estate tax by gifting to ultimate intended beneficiaries now instead of as part of the estate transfer.

For the past several years the lifetime gifting limit has been pegged at $1 million, while the estate tax exclusion drifted up, then went away altogether in 2010, and is now set at $5million for 2011 and 2012.  But at least for these two years, the ‘unified estate and gift tax’ is once again united at the same level, and an aggressive gifting program can move lots of wealth to a younger generation totally tax free!  Some families may realize that substantial amounts can be moved tax free, and they are not limited to the annual $13,000 exclusion amount with which most people are accustomed to dealing.  Larger gifts that exceed the annual ‘de minimus’  $13,000 limit will require filing annual forms 709, but if less than $5 million is involved, no tax will have to be paid.

Our ‘voluntary’ tax system basically assesses a tax on transfers of money or value from one person to another.  Most of the transfers are of an ‘income’ nature, and the related tax is paid by the recipient. However, gifting is a different kind of transfer, and requires any tax to be paid by the donor/grantor.  So the door is wide open for the many citizens whose estates are $10 million or less, to avoid estate tax altogether by acting during 2011 and 2012.  Many have established trusts somewhere along the line, and these should be updated for the law change.  It may now even be possible to eliminate the trust and just transfer those pesky assets away to the kids or grandchildren, while you are here to enjoy seeing the benefits of your generosity.  And if you do decide to take full advantage, be sure to thank your elected representative for leaving the barn door open for a little while anyway.

For those with personal emergencies, and many who are dependent upon others and normally experience delays while waiting for those late K-1’s or delinquent 1099’s, know that there is a right way and a wrong way to deal with the deadline.  The wrong way is to shrug it off or to go (the uncompleted) extension route..  The extension process (now available on line) is simpler now that the IRS and FTB both recognize that automatic approvals encourage more people to at least try to comply with the deadline.  What many don’t realize, or don’t bother to read far enough into the instructions to form 4868 (IRS) or form 3519 (FTB), is that any tax expected to be due with returns when finally completed, is due NOW.  The extension only secures time to process the data and file the returns, NOT to pay the tax! But how do we know how much is owed?

For many years there was no solution, and penalties were rampant.  But a few years ago the Tax Court got involved in a case and ruled in favor of a Dr. Sullivan, establishing a precedent for future late filers.  Basically, the ruling provides that so long as a taxpayer makes a diligent effort to accurately estimate the tax due, there will be no penalty later if the estimate is wrong! Soooo, the right way to deal with extensions is to go through the exercise of return preparation, and for those places where data is unavailable, refer to last year’s return, GUESS, and continue with the preparation process.  But make some notes on how or why you arrived at the ‘guesstimates’ used, and you will be fine! Pay the tax you calculate, and you now have six more months – until October 15, to complete the job.

For many who are self-employed, or who fund IRA’s in early April, the April 15 deadline is a BAD day!  Cash flow is critical at this point, since funds are needed to pay 1) last year’s tax, 2) any retirement plan funding needed to minimize that amount, AND 3) the first quarterly estimate for the current year’s tax.  On top of that, many small businesses need to make their monthly payroll tax deposit by that day as well!  Mid-April is a time that many taxpayers dread and that truly alienates them from the legislators that continually argue for increasing taxes, while they are enjoying the exemption from dealing with the laws the rest of us can’t ignore.

But the key pointer, for those too busy or disorganized to get their tax act together properly, the simple thing to do is estimate high, overpay a little, and when returns are complete, have the excess payment applied to the next year! That way you begin getting ahead a little, since the carryover will provide a cushion, or enable you to reduce the last estimated payment, or cut back your withholding later in the year, to compensate for the overpayment/credit. SIMPLE and effective!  And for those expecting refunds, not to worry at all, since penalties are only based on tax due, and the reverse does not apply.  Penalties are ignored when refunds are involved! So while it is best to deal with returns timely, if life’s emergencies have happened to you during 2010, do not stress out over the tax deadline, since there is an easy way to buy the extra time you need– with an application for extension of time to file.  And the FTB is even easier to deal with IF you don’t owe them anything!  NOTHING needs to be filed now at all, and the federal extension covers your intent.

Answer – It depends. There are 5 criteria that need to be satisfied before anyone can be properly claimed as a dependent.
They are: relationship, citizenship or residency, marital status, age and ‘qualifying support.’ He obviously meets the first two, but if he’s married and being included on another tax return, you can’t claim him. The last one is the tough one to meet for an adult dependent. But it is possible, if his income or support payments being received or provided by another person (pension, social security, disability benefits, child or spousal support, etc.) is small or he has none, then the ‘support’ you are providing may be sufficient. Support is his share of the cost of food, clothing, shelter, transportation and medical care. Figure the amount you spent last year for those categories of cost, divided by the number of people in your household, = his share.  It must be more than ½ of his separate income or support described above. Taxability of his ‘income’ is not a factor.  Failure to make sure he’s not being claimed by anyone else will likely result in both returns being audited!  Multiple support agreements are common between children caring for aging or disabled parents, or any ‘supported’ adult.

Answer – Congress established our system of taxation by designing it around transfer activity. Basically, we have to pay tax anytime there is an agreed-upon transfer/exchange between parties – goods for goods or for services. The parties agree on the fairness of the exchange of value.  It is up to each to assign a monetary amount to the transaction and yes, to report it as part of their income subject to tax. The occasional transaction value would be reported on the ‘Other income’ line on page 1 of form 1040. If a business does exchanges, the income received is also potentially subject to self-employment tax! A business owner reports bartered benefit value on Schedule C as Other Income. And the IRS finds out about any ‘bartering’ activity by asking you directly at the very beginning of any audit.  Rules about bartering are clearly a part of the Internal Revenue Code!

1)    I just received a 1099-C from our mortgage company and I realize it must be related to our house foreclosure.  Do we have to pay tax on the amount they included on the form—on top of losing our house?
Answer—It depends on whether you have refinanced or not. Purchase money mortgages, original mortgage loans in California, are non-recourse debt, and as such will not constitute taxable income.  But you will have to report the sale of your house, using the balance of the loan at the time of foreclosure as the selling price. The other rules pertaining to sale of residence gain exclusions will likely result in no tax from the foreclosure—small consolation, all things considered.

2)    We negotiated away part of our credit card debt last year. Now we get a 1099 in the mail reporting the reduction as income. If we do have to include that in our tax return, where does it go? Any difference if the cards were all related to our business?
Answer- yes you do get to include that as income, on line 21 of your 1040. You may also note that interest and fees charged to you will be included in the computation of what is reported as cancelled. And business use may make a difference—it could result in  the reported amount showing up on Schedule C as Other Income, which would make it subject to SE tax if the net business activity shows a profit!

The variety of circumstances resulting in reported debt cancellation are substantial, and there are several exclusions provided by Congress so not all 1099-C’s will result in taxable income.  Very likely returns will have to include a Form 982 claiming which of the six (6) exclusions apply. And it is possible the reported amount is incorrect, so retaining records even in a repossession situation may be important to be confident yours has not been over reported!

Contributions to foreign organizations generally are not deductible. To get a tax benefit for making a charitable contribution, taxpayers must itemize their deductions on Schedule A for the year in which they made the contribution. IRS Publication 526, Charitable Contributions, provides information on making contributions to charities. Publication 3833, Disaster Relief: Providing Assistance through Charitable Organizations, explains how the public can use charitable organizations to help victims of disasters, and how new organizations can obtain tax-exempt status. Both publications are available on IRS.gov.

Based on internal studies and estimates, IRS is working on a major compliance initiative to identify gift tax cheats. Apparently about ¾ of inter-family transfers of real estate never get reported on a gift tax return!  The potential for underpaid gift tax is significant with that kind of volume.  So, not all those new auditors will be looking at income tax filings.  Considering the vast amount of wealth that is set to be transferred to the next generation within the next few years, IRS seems to be positioning itself to ensure that the $1million lifetime gift tax exclusion amount has been exhausted before the estate tax return has to be filed!

A word of advice – consult with a professional on any tax authority correspondence, and definitely in the event you are selected for an audit. Someone familiar with auditing procedures can make a big difference.

IRS just recently released the statistical results from last year’s return processing. You may find the following information useful as you gather your 2010 data and documents.

• Approximately 139 million individual returns were filed last year.

• IRS completed almost 1.5 million audits, just about the same number as in ’09, so you can estimate your chance of being audited—just about 1%. But a larger percentage for high income filers –6.4% for individuals with more than $1 million income, so for most normal, middle class folks, our chance of being audited is even less than 1%.

• For those who operate business as corporations, know that the audit rate for corporations was 1.3%, again with a focus on the larger ones—up to 15% of those with assets exceeding 10 million.  So the big guys get the attention!

• There is a definite trend toward ‘correspondence’ audits, conducted entirely by mail. Seems that almost 75% of individual audits were conducted in this manner (much less confrontational, but still requiring the same level of documentary support).

All tax filers should be alert to the fact that IRS spends a lot of money every year on enhancements to their computer systems.  They used to be the largest purchaser of artificial intelligence software in the world.  And it works for them.  Recent experience revealed a new tactic being implemented as a standard part of every examination, whether conducted in their office or on-site (which is their preference for businesses). A number of questions are posed early in the interview, in a focused effort to identify underreported income. The questions are the result of a computer evaluation of the likelihood of same, based on statistically-derived living costs in the general geographic area where the taxpayer resides.  The unique focus on income is new!  Conclusion: anyone reporting a negative or very low amount of taxable income should be prepared to defend their reported low income amounts. Better have the information on loans, inheritance, etc. that must have provided the resources to pay all the bills showing on the return, plus all the (IRS derived) personal costs of living that never show up on returns!

Other statistics are available on IRS website. Search for ‘statistics of income’ for useful benchmark data which could help identify areas that might attract IRS attention in your return!

Tax season 2010 is upon us and we are here to help with all your personal or business tax preparation and financial planning.

Contact us by mail, phone & fax or email

P.O. Box 509 Foresthill, CA 95631

ph: (530) 367-3520

(916) 961-1494

fax: (530) 367-6564

email: jntaxman@gmail.com

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