SDC Tax and Business Services

Individuals tend to be complacent about preparing for their own eventual demise, mostly because it is something they do not want to think about. However, it is an inevitable part of life, and planning for it ahead of time would benefit both you and your loved ones. Before setting up your estate plan, the following items should be taken into consideration.

• Structure your estate plan to take advantage of dual estate tax exemptions – When an individual passes away, the first $2 million (in 2008) of their taxable estate is exempt from federal estate tax (inheritance tax). Any amount over that is subject to tax. For married couples, there is an unlimited marital exemption so that the surviving spouse can inherit the deceased spouse’s estate without paying any inheritance tax. Consequently, the entire joint assets are placed in the surviving spouse’s estate, and when the surviving spouse passes, his or her estate only receives the benefit of a single estate tax exemption.

However, a married couple can escape estate tax on assets of up to two times the exemption amount ($4 million in 2008 or $7 million in 2009) if the couple's wills are drafted to take full advantage of each spouse's own exemption amount. The wills should provide that, when the first spouse dies, the amount protected from estate tax by the available exemption amount passes to a trust, from which the surviving spouse can benefit during his or her remaining lifetime, but which will not be included in the surviving spouse's estate at death.

If you own a home, carry some life insurance, and are entitled to retirement plan benefits from work, your gross estate may already exceed the threshold at which estate tax liability begins. Since the top estate tax rate is 45%, planning to make the best use of your exemption is essential. For individuals with very large estates, there are additional estate planning techniques that can help maximize the amount of your estate that will pass to your heirs.

• Make adequate beneficiary designations – The beneficiary designations for your insurance policies, annuities, employer retirement plans, and IRA accounts should be up-to-date and coordinated with your overall estate plan. You may also have designations that are no longer appropriate due to deaths, marriage, divorce or other issues that have changed over the years. There are also tax rules that specify distribution options for IRA and pension plans that should be considered in your estate plan. Failure to properly plan could result in disastrous income and estate tax results.

• Consider the options available to finance long-term care needs – The life expectancy of Americans continues to increase, and the older we become, the less likely we are able to live independently. An AARP study has found that 82% of individuals age 85 and older have a chronic condition or disability for which they might need assistance. The cost of nursing and hospice care can quickly devour your personal financial resources and ultimately burden your spouse or other loved ones. Unless you are wealthy enough to be self-insured, planning options to consider include long-term care insurance or life insurance to replace the wealth lost by the family to long-term care costs. Although Medicaid is another source of funds for long-term care financing, it may not provide a standard of living that is desirable.

If you have a specific question regarding any of the information provided here, please call our office for an appointment.

By the time you read this article, the IRS has already started sending out the stimulus rebates. A new schedule was released, accelerating the distribution of the payments. Payments were direct deposited into qualifying individuals' bank accounts starting April 28 instead of May 2, and paper checks will be mailed starting May 9 instead of May 16. The schedule that was released in March remains the same, with payments either direct deposited or put in the mail by the dates listed on the schedule.

These rebates are actually advance payments for a new refundable tax credit called the “Recovery Rebate Credit” that is claimed on your 2008 tax return and must be accounted for when you file the 2008 tax return. So the government can get the money into people’s hands quickly and not wait for the 2008 returns to be filed in 2009, the IRS will calculate and mail out advance payments of this 2008 credit based upon the information included on a taxpayer’s 2007 tax return. The IRS will make a direct deposit of the advance payment into a taxpayer’s account if direct deposit was requested for the 2007 return refund. When the taxpayer files his or her 2008 return, the Recovery Rebate Credit will be reduced by the amount of the advance payment. Should the advance payment exceed the amount of the credit, the taxpayer will not be required to make up the difference!

Since these advance payments (cash rebates) are computed based on the data from the 2007 return, a 2007 return must be filed to obtain a cash rebate. Thus, some taxpayers (such as those receiving SS income and who are not otherwise required to file a return and otherwise qualify for the rebate) must file one to qualify for the advance payment. However, if a taxpayer does not file a 2007 return, he or she still would qualify for the Recovery Rebate Credit when a 2008 return is filed. This also applies to taxpayers who file late. They do not lose the Recovery Rebate Credit; they just do not receive it in advance and will have to wait for the benefit when their 2008 return is filed. The IRS is prohibited from issuing advance payments after December 31, 2008.

How much will your rebate be? The rebates are broken into two categories, the basic credit rebate and the qualifying child rebate credit. For the basic credit rebate, a single person with no qualifying children gets a maximum rebate of $600 or a minimum rebate of $300. A married couple filing jointly with no qualifying children gets a maximum rebate of $1,200 or a minimum rebate of $600. To receive the maximum, your 2007 tax (figured in a special way) must be $600 or more for a single person and $1,200 or more for a married couple filing jointly. To get the minimum, you must have at least $3,000 of qualifying income (explained above) or owe tax (figured in a special way) of at least $1. Your rebate amount will fall in between the minimum and maximum if your tax is more than $300 but less than the maximum rebate for your filing status. In that case, your rebate will be equal to your tax. Let’s say that you are single and that your tax is $500. In this scenario, your rebate will be $500.

An eligible individual who is entitled to any amount of the basic credit is also allowed a credit equal to $300 for each qualifying child of the individual in addition to the basic credit. “Qualifying child” has the same meaning for this purpose as it has for purposes of the child tax credit. Thus, for each child who qualifies for the child tax credit, a taxpayer qualifies for an additional $300 rebate.
For example, a married couple filing jointly with one qualifying child could be eligible for a maximum rebate of $1,500 ($1,200 $300).

Phase-out for higher-income taxpayers: The amount of the rebate (both the basic and the child amount) is reduced by 5% of a taxpayer’s adjusted gross income (AGI) above $75,000 ($150,000 for joint returns). For example, a married couple filing jointly with one child has an AGI of $170,000 and a net tax liability of over $1,200. Their rebate is $500: [$1,200 basic rebate plus $300 qualifying child rebate - $1,000 phase-out (i.e., 5% × ($170,000 - $150,000)].

Do all qualified individuals get rebates? No. Each individual must qualify for the rebates in one of two ways, and the rebates and the credit in 2008 is phased out for higher-income taxpayers. To qualify, a taxpayer must (1) owe tax, as computed in a special way, or (2) have at least $3,000 of qualifying income. Qualifying income generally includes earned income, social security benefits, and veterans’ disability payments (including payments to survivors of disabled veterans).

If you think that you might qualify for the rebate and have not yet filed a return, please call this office for assistance.

When individuals change jobs, they generally move their 401(k) plan to their new employer’s plan or transfer them into an IRA account. The law allows you take a distribution and then redeposit the funds into the new account or to make a trustee-to-trustee transfer from the prior account to the new one.

It is generally better, for tax reporting issues, to make a trustee-to-trustee transfer between plans rather than to take a distribution. This avoids the reporting issues on your tax returns and any possibility of the transfer ending up being taxable. If you take a distribution, keep in mind that the rollover must be completed within 60 days or it becomes taxable. If you are considering your new employer’s plan, investigate your investment options and plan fees before making the transfer.

The failure to file a federal tax return can be costly — whether you end up owing more or missing out on a refund.

There are several reasons taxpayers don’t file their taxes. Perhaps you didn’t know you were required to file. Maybe, you just kept putting it off and simply forgot. Whatever the reason, it’s best to file your return as soon as possible. If you need help, even with a late return, the IRS is ready to assist you.
Here are some things to consider:

• Failure to File Penalty. If you owe taxes, a delay in filing may result in a "failure to file" penalty, also known as the “late filing” penalty and interest charges. The longer you delay, the larger these charges grow.

• Losing your Refund. There is no penalty for failure to file if you are due a refund. However, you cannot obtain a refund without filing a tax return. If you wait too long to file, you may risk losing the refund altogether. The federal deadline for claiming refunds is three years after the return due date. For example, the last day for claiming a federal refund for your 2004 tax return will be April 15, 2008.

• EITC. Individuals who are entitled to the Earned Income Tax Credit must file their return to claim the credit even if they are not otherwise required to file.

Whether or not you must file a tax return will depend upon a number of factors, including your filing status, age and gross income. Please call for assistance.

Newlyweds and the recently divorced taxpayers should ensure the name on their tax return matches the name registered with the Social Security Administration (SSA). A mismatch could unexpectedly delay a tax refund.

• For recently married taxpayers, the tax scenario begins when the bride says "I do." If she takes her husband's last name, but doesn't tell the SSA about the name change, a complication may result. If the couple files a joint tax return with her new name, the IRS computers will not be able to match the new name with the Social Security Number (SSN). If a new spouse has not made the change with the SSA administration, she should use her old name on the tax return.

• After a divorce, a woman who had taken her husband’s name and made that change known to the SSA should contact the SSA if she reassumes a previous name.

The key to avoiding filing problems is to match the tax return name with what the SSA has on record for that SSN.

It's easy to inform the SSA of a name change by filing Form SS-5 at a local SSA office. It usually takes two weeks to have the change verified. The form is available on the agency's web site at www.socialsecurity.gov or by calling 800-772-1213 and at local offices. The SSA web site provides the addresses of local offices.

As the April 15 deadline approaches, we begin to receive calls from taxpayers who do not have the ready cash needed to pay their tax liability. There are significant penalties for failing to pay your tax liability by the April 15 due date.

Whether paying with a timely filed tax return, or filing and paying late after receiving a bill from the IRS (and we have determined the bill is correct), taxpayers are encouraged to pay the taxes they owe in full. If taxes are not paid, and no effort is made to pay them, the IRS can ask a taxpayer to take action to pay the taxes, such as selling or mortgaging any assets owned or getting a loan. If the taxpayer continues to make no effort to pay the bill, or other payment arrangements have not been made, the IRS could take more drastic measures, such as levying bank accounts, wages, or other income, or taking other assets. A Notice of Federal Tax Lien could be filed that may have a detrimental effect on a taxpayer’s credit standing.

The penalties and interest charged by the IRS are substantially higher than most commercial lending rates, so it is generally better to borrow the funds elsewhere and pay the IRS in full. Where taxpayers cannot raise part or all of the funds to pay their taxes by conventional means, the IRS offers credit card payment and installment agreements.

Credit Card Payment – Payments can be made by credit card. However, the IRS does not pay the discount fees of credit card companies, so that is an additional fee that will be added to your credit card charge. If you are considering paying by credit card to increase your airline miles, forget it. The cost is more than the miles are worth! Payments by credit card can be made through one of two official vendors:

• Official Payments Corporation at 1-800-2PAYTAX (1-800-272-9829) - www.officialpayments.com, or

• Link2Gov at 1-888-PAY1040 (1-888-729-1040) - www.pay1040.com.

Installment Agreement – Taxpayers wishing to pay off a tax debt through an installment agreement, and owe:

• $25,000 or less in combined tax, penalties, and interest can apply for an installment agreement using a simplified procedure.

• More than $25,000 in combined tax, penalties, and interest may still qualify for an installment agreement, but must complete a more complex application including the submission of financial statements.

The IRS user fee for setting up an installment agreement is $52 for direct debit agreements and $105 for non-direct debit agreements. Certain low-income taxpayers will qualify for a reduced fee of $43. These fees must be paid with the first installment. You will also be charged interest and may be charged a late payment penalty on any tax not paid by its due date, even if your request to pay in installments is granted. Interest and any applicable penalties will be charged until the balance is paid in full.

If you are unable to pay your liability in full, please call this office as soon as possible. Procrastination can lead to further problems, penalties and interest.

Now that you have your taxes completed for 2007, you are probably wondering what old records can be discarded. If you are like most taxpayers, you have records from years ago that you are afraid to throw away. It would be helpful to understand why the records needed to be kept in the first place.

Generally, we keep “tax” records for two basic reasons: (1) we need to keep the records in case the IRS or a state agency decides to question the information reported on our tax returns, and (2) we need to keep track of the tax basis of our capital assets so when we actually dispose of them we can minimize the tax liability.

With certain exceptions, the statute for assessing additional tax is three years from the return due date or the date the return was filed, whichever is later. However, the statute of limitations for many states is one year longer than the federal. In addition to lengthened state statutes clouding the recordkeeping issue, the federal three-year assessment period is extended to six years if a taxpayer omits from gross income an amount that is more than 25 percent of the income reported on a tax return. And of course, the statutes don’t begin running until a return has been filed. There is no limit where a taxpayer files a false or fraudulent return in order to evade tax.

If an exception does not apply to you, for federal purposes, you can probably discard most of your tax records that are more than three years old; add a year or so to that if you live in a state with a longer statute.

Examples - Sue filed her 2004 tax return before the due date of April 15, 2005. She will be able to dispose of most of her records safely after April 15, 2008. On the other hand, Don filed his 2004 return on June 2, 2005. He needs to keep his records at least until June 2, 2008. In both cases, the taxpayers may opt to keep their records a year or two longer if their states have a statute of limitations longer than three years. Note: If a due date falls on a Saturday, Sunday or holiday, the due date becomes the next business day.

The big problem! The problem with the carte blanche discarding of records for a particular year because the statute of limitations has expired is that many taxpayers combine their normal tax records and the records needed to substantiate the basis of capital assets. They need to be separated and the basis records should not be discarded before the statute expires for the year in which the asset is disposed. Thus, it makes more sense to keep those records separated by asset. The following are examples of records that fall into that category:

• Stock acquisition data - If you own stock in a corporation, keep the purchase records for at least four years after the year the stock is sold. This data will be needed in order to prove the amount of profit (or loss) you had on the sale.

• Stock and mutual fund statements – Where you reinvest dividends. Many taxpayers use the dividends they receive from a stock or mutual fund to buy more shares of the same stock or fund. The reinvested amounts add to the basis in the property and reduce gain when it is finally sold. Keep statements at least four years after final sale.

• Tangible property purchase and improvement records - Keep records of home, investment, rental property, or business property acquisitions AND related capital improvements for at least four years after the underlying property is sold.

Have questions about whether or not to retain certain records? Give us a call first; it is better to make sure before discarding something that might be needed down the road.

For example, when the large $250,000 and $500,000 home exclusion was passed into law several years back, homeowners became lax in maintaining home improvement records thinking that the large exclusions would cover any potential appreciation in the home’s value. Guess what happened during the real estate boom? The exclusion was not always enough! Records can be important, so please use caution when discarding them.

Just a reminder to those who have not yet filed their 2007 tax return that April 15 is the due date to either file your return, pay any taxes owed, or file for the automatic six-month extension.

In addition, the April 15, 2008 deadline also applies to the following:

• Tax year 2007 balance-due payments – Taxpayers that are filing extensions are cautioned that the filing extension is an extension to file, NOT an extension to pay a balance due. Late payment penalties and interest will be assessed on any balance due, even for returns on extension. Taxpayers anticipating a balance due will need to estimate this amount and include their payment with the extension request.

• Tax year 2007 contributions to a Roth or traditional IRA – April 15 is the last day contributions can be made to either a Roth or traditional IRA, even if an extension is filed.

• Individual estimated tax payments for the first quarter of 2008 – Taxpayers, especially those who have filed for an extension, are cautioned that the first installment of the 2008 estimated taxes are due on April 15. If you are on extension and anticipate a refund, all or a portion of the refund can be allocated to this quarter’s payment on the final return when it is filed at a later date. Please call our office for any questions.

• Individual refund claims for tax year 2004 – The regular three-year statute of limitations expires on April 15 for the 2004 tax return. Thus, April 15 is the last day a refund will be granted for any return or amended return for 2004. Caution: The statute does not apply to balances due for unfiled 2004 returns.

If we are holding up the completion of your returns because of missing information, we urge you to forward that information as quickly as possible in order to meet the April 15 deadline. Keep in mind that the last week of tax season is very hectic, and we may not be able to complete your returns if you wait until the last minute. If it is apparent that the information will not be available in time for the April 15 deadline, then let us know right away, so we may prepare an extension request and estimate tax vouchers if needed.

If we still have not met with you this year, we urge you to call right away, so that we can schedule an appointment and/or file an extension if necessary.


Filing as soon as possible takes on a new significance this year, since the cash rebates will only be issued to those who have filed a 2007 tax return. This rule applies to those who normally do not file but qualify for the rebate. Please call this office if you have questions.

April 15 is the due date for the first estimated tax installment for the 2008 tax year and only a couple of weeks away.

You may not realize it, but taking a few minutes to plan your estimated tax payments and/or proper withholding amounts for the year can actually insulate you from underpayment penalties in 2009.

Congress considers our tax system as a "pay-as-you-go" system. To facilitate that concept, the government has provided several means of assisting taxpayers in meeting the "pay-as-you-go" requirement. These include:

• Payroll withholding for employers;

• Pension withholding for retirees; and

• Estimated tax payments for self-employed individuals and those with other sources of income not covered by withholding.

When a taxpayer fails to prepay a safe harbor (minimum) amount, they can be subject to the underpayment penalty. This nondeductible interest penalty is higher than what you might earn from a bank and is computed on a quarter-by-quarter basis.

Safe Harbor Payments – Federal law and most states have safe harbor rules. There are two Federal safe harbor amounts that apply when the payments are made evenly throughout the year:

1. The first safe harbor is based on the tax owed in the current year. If your payments equal or exceed 90% of your current year’s tax liability, you can escape a penalty.

2. The second safe harbor – and the one taxpayers rely on most often – is based on your tax in the immediately preceding tax year. If your current year’s payments equal or exceed 100% of the amount of your prior year’s tax, you can escape a penalty. If your prior year’s adjusted gross income was more than $150,000 ($75,000 if you file married separate status), then your payments for the current year must be 110% of the prior year’s tax to meet the safe harbor amount.

Where taxpayers get into trouble is when their income goes up or their withholding goes down for the current year versus the prior year. Examples are having a substantial increase in income, such as when investments are cashed in, thereby increasing income but without any corresponding withholding or estimated payments. Another frequently encountered situation is when a taxpayer retires and his payroll income is replaced with pension and Social Security income without adequate withholding. Taxpayers who don’t recognize these types of situations often find themselves substantially underpaid and subject to the underpayment penalty when tax time comes around.

Bottom line, 100% (or 110% for upper-income taxpayers) of your prior year’s total tax is the only true safe harbor because it is based on the prior year’s tax (a known amount), whereas the 90% of the current year’s tax amount is a variable based on the income for the current year, and often that amount isn’t determined until it is too late to adjust the prepayment amounts.

Therefore, it is very important that you bring any potential tax events to our attention, so that we might suggest adjustments to your withholding or provide you with estimated payment vouchers.

Are you expecting a refund and wondering where it is? If you owe back taxes, child support, or have a student loan balance, etc., the refund may have gone there. Otherwise, the IRS has a tool on their website that can track down your refund.

Whether you chose to split your refund among several accounts, opted for direct deposit to one account, or asked the IRS to mail you a check, you can track your refund through their secure web site.

CAUTION If you received an e-mail regarding your refund requesting personal information, such as your Social Security number, bank account numbers, etc., do not respond! The IRS never initiates e-mails to taxpayers, and the e-mail is probably a scam to obtain your personal information.

To access your personal refund information, go to the IRS Where’s My Refund? website. For security reasons, you will need to provide the following:

• Social Security Number (or IRS Individual Taxpayer Identification Number)

• Filing status (Single, Married Filing Joint Return, Married Filing Separate Return, Head of Household or Qualifying Widow(er))

• Exact refund amount shown on your return

If you have not received your refund within 28 days from the original IRS mailing date shown on Where’s My Refund?, you will be prompted to start a refund trace online.

If Where’s My Refund? shows that the IRS was unable to deliver your refund, you will be prompted to change your address online.

As reported in a statement issued by IRS, it has continued to make strong progress in a number of key enforcement areas. IRS enforcement efforts increased in fiscal year 2007; overall, enforcement revenue reached $59.2 billion, up from $48.7 billion in 2006.

Individual enforcement - Overall, the total individual return audits were up 7% in 2007. The table below is a summary of IRS audit activity for fiscal year 2007:

(1)One out of 11 individuals with incomes of $1 million or more faced an audit in 2007.

Business enforcement – Overall, the total business return audits were up 14% in 2007. The table below is a summary of IRS audit activity for fiscal year 2007:

(2)Assets between $10 million and $50 million dollars

A question that often arises is whether prepaid business expenses can be deducted in the year it is paid. Unfortunately, they cannot. Generally, where an expense relates to a period covering more than 12 months, the IRS and most courts agree that the deduction must be spread over the period to which the expense applies.

For example, you purchase a three-year maintenance plan for your office photocopy machines. The service company offers you a discount to prepay the contract, which you end up doing. In this case, the expense must be amortized (ratably deducted) over the three-year period and not all at once in the year paid. If you had only prepaid three months of the contract, that amount would have been deductible in the year paid. This rule precludes business owners from prepaying expenses as a means to reducing their profits for a particular year.

If you have questions regarding prepaid expenses, please give us a call.

If you gave any one person gifts in 2007 that are valued at more than $12,000, you must report the total gifts to the Internal Revenue Service even if you have not exceeded the $1 million gift tax exemption. The gift tax return is used to track the nontaxable gifts and determine when gifts from all years exceed the gift exemption and become taxable. The person who receives your gift does not have to report the gift to the IRS or pay gift or income tax on its value.

Gifts include money and property, including the use of property without expecting to receive something of equal value in return. If you sell something at less than its value or make an interest-free or reduced-interest loan, you may be making a gift.

There are some exceptions to the tax rules on gifts. The following gifts generally are not taxable and do not count against the annual limit:

• Tuition or Medical Expenses that you pay directly to an educational or medical institution for someone's benefit
• Gifts to your Spouse
• Gifts to a Political Organization for its use
• Gifts to Charities

If you are married, both you and your spouse can give separate gifts of up to the annual limit of $12,000 to the same person without making a taxable gift.

Alternatively, with consent from your spouse, you can make a gift of up to $24,000 ($12,000 x 2) to the same person without making a taxable gift. This is commonly known as splitting gifts between spouses. Essentially, it means a gift by you or your spouse to a third person can be considered as made one-half by each of you provided there is consent by both spouses.

If you need assistance determining if you are liable for a gift tax return, please give us a call.

With lenders becoming more conservative, money tightening up, and the real estate market in decline, many homeowners and speculators find themselves faced with some unpleasant choices. One strategy is to wait until home prices rebound, but that could be some time and probably too far off for the owner with a variable rate or short-term introductory rate loan and increasing mortgage payments.

There are other reasons—such as job relocation, divorce, declining income or poor health—that can force a property owner to sell in a down market and possibly take a financial loss. This article explores the tax ramifications of selling a home or rental property at a loss. But first, here are some terminology and tax rules associated with selling property:

• Personal-Use Property - The general rule that applies to personal-use property is that gains are taxable as capital gains but losses are not deductible. Examples of personal-use property are the family car (no business use) and the family home or second home. So, if you sell your personal residence or second residence at a loss, that loss is not deductible.

• Investment Property – For investment property, generally, gains are taxable and losses are deductible as capital gains/losses. However, the amount of capital loss that can be deducted annually is limited. If, after combining all investment capital gains and losses, the result is a loss, the loss is generally limited to $3,000 per year. Examples of investment property include vacant land or improved real estate that is not a business property, home or second home.

• Business Property – The general rule for business property is that gains are taxable as capital gains and losses are deductible as ordinary income. Examples of business property include residential rentals, commercial rentals and an office-in-the-home.

• Primary Home Sale Gain Exclusion – Generally, an individual who owns and lives in a home for two of the prior five years can exclude $250,000 of home sale gain. This applies to each individual so a couple could exclude $500,000. In addition, an individual who does not meet the two-out-of-five requirements may still be able to exclude a lesser amount if the home was sold due to certain unforeseen circumstances.

Now let’s apply these general rules to some representative situations that are likely to occur in a down real estate market.

Example #1 – You sell your primary (or second) home for a loss when taking into consideration what you originally paid for the home, improvements and the sales costs. Bad news - your home is personal use property and losses from “personal-use property” are not deductible. Thus, there is no tax relief from having a loss on the sale of your primary or secondary home.

Example #2 – You purchased a residential or commercial property as a rental. Now the value has declined below your basis and a sale will result in a loss. Since it is business property, the entire loss will be deductible as ordinary income in the year of sale. Thus, you will achieve tax relief based on your tax bracket(s) in the year of sale. Caution: The depreciation of the real property that you claimed as a rental expense decreases your cost basis. This means that you could actually end up with a tax gain on the sale when you thought you would have a loss.

Example #3 – You purchased vacant land for an investment and need to sell it. Unfortunately, the sale will result in a loss. The good news is the loss is tax-deductible, but lacking any capital gains to offset the loss, you will only be able to deduct $3,000 ($1,500 if filing as married separate) of the loss in the sale year; the excess loss carries over to future years.

Example #4 – Your home that you are selling for a loss includes an office from which you conduct your business. The home office is deductible under the income tax rules, and represents 10% of the home. In this case, 10% of the loss would be deductible as an ordinary loss in the sale year. None of the remaining 90% of the loss is deductible due to the personal- use property rules.

Example #5 – Yes, we read your mind. You are planning to move out of your home that will sell for a loss and convert it to a rental thinking you could then deduct the loss. Problem with this strategy is that tax law requires you to use the fair market value (FMV) of the home at the time of conversion as the business basis if the FMV is less than your adjusted cost basis. Thus, the loss in value that occurred prior to the conversion will not be included in your loss when you sell the rental. However, if the market continues to decline, you will be able to take advantage of any future losses.

Example #6 – The property will sell for a loss, so you decide to just let it go into foreclosure. By doing this, you avoid the sales costs but destroy your credit rating for years to come. In addition, if the property sells at auction for less than the mortgage balance, you may, depending on some complicated rules, have to include in your income the difference between the loan amount and the sales price (referred to as debt relief income).

Example #7 – Let’s say you originally purchased your home for $200,000; it increased in value to $300,000, so you refinanced it for $240,000 and used the money to buy a car, go on vacation, pay off credit card balances, etc. Now your mortgage is higher than both your basis (cost) in the home and its current value. Your home sells for $225,000, and assuming you have $10,000 in sales costs, you end up with a tax gain of $15,000 rather than a loss, which may come as a surprise. The gain may or may not be taxable depending upon whether you qualify for the home sale gain exclusion. Bad news is you need to make up the $15,000 mortgage shortage and the $10,000 sales costs.

We strongly suggest you carefully weigh your options before selecting a course of action. A consultation appointment may be appropriate to see what option is the best for your particular tax situation. Please give us a call.

The EITC is for people who work, but have lower incomes. If you qualify, it could be worth up to $4,700 this year. So, you could pay less federal tax or even get a refund. The credit is a refundable credit, so you can receive the benefits of the credit even if you may not owe any taxes. That’s money you can use to make a difference in your life.

In Tax Year 2006, over 22.4 million taxpayers received $43.7 billion dollars in EITC – making the credit a great investment in the lives of those who claim it. However, the IRS estimates 20 to 25 percent of people who qualify for the credit do not claim it. At the same time, there are millions of Americans who have claimed the credit in error, many of whom simply don’t understand the criteria.

The EITC is based on the amount of your earned income and whether or not there are qualifying children in your household. If you have children, they must meet the relationship, age and residency requirements. Additionally, you must file a tax return to claim the credit.

If you were employed for at least part of 2007, you may be eligible for the EITC based on these general requirements:

• You earned less than $12,590 ($14,590 if married filing jointly) and did not have any qualifying children.

• You earned less than $33,241 ($35,241 if married filing jointly) and have one qualifying child.

• You earned less than $37,783 ($39,783 if married filing jointly) and have more than one qualifying child.

In addition, you must meet a few basic rules:

• You must have a valid Social Security Number.

• You must have earned income from employment or from self-employment.

• Your filing status cannot be married, filing separately.

• You must be a U.S. citizen or resident alien all year, or a nonresident alien married to a U.S. citizen or resident alien, and filing a joint return.

• You cannot be a qualifying child of another person.

• If you do not have a qualifying child, you must:
o be age 25 but under 65 at the end of the year,
o live in the United States for more than half the year, and
o not be a qualifying child of another person.

• You cannot file Form 2555 or 2555-EZ (related to foreign earned income).

Members of the military can elect to include their nontaxable combat pay in earned income for the earned income credit. If you make the election, you must include in earned income all nontaxable combat pay received. If you are filing a joint return and both you and your spouse received nontaxable combat pay, then each of you can make your own election. The amount of your nontaxable combat pay should be shown on your Form W-2 in box 12 with code Q.

If you have any questions, please give this office a call.

We can generally provide you with copies of tax returns prepared by the office for current and three prior calendar years. There may be a nominal reproduction charge. Please keep in mind, that due to privacy laws, we can only provide the copy to you and not to a third party. If you would like copies of returns that were not prepared by this firm, you can easily obtain tax return or tax account transcripts by phone or mail directly from the IRS.

A tax return transcript shows most line items from the tax return (Form 1040, 1040A or 1040EZ) as it was originally filed, including any accompanying forms and schedules. It does not reflect any changes you, your representative, or the IRS made after the return was filed. In many cases, a return transcript will meet the requirements of lending institutions such as those offering mortgages and student loans. You should receive your tax return transcript within 10 working days from the time the IRS receives your request.

A tax account transcript shows any later adjustments either you or the IRS made after the tax return was filed. This transcript shows basic data, including marital status, type of return filed, adjusted gross income and taxable income. The IRS does not charge a fee for transcripts, which are available for the current and three prior calendar years. Allow 30 calendar days for delivery of a tax account transcript.

To request either transcript:

• By phone: Call 800-829-1040 and follow the prompts in the recorded message.

• By mail: Complete IRS Form 4506-T, Request for Transcript of Tax Return. If you need a photocopy of a previously processed tax return and attachments, complete Form 4506, Request for Copy of Tax Form, and mail it to the IRS address listed on the form for your area. There is a fee of $39.00 for each tax period requested. Copies are generally available for the current and past six years.

Forms 4506-T and 4506 can be found on the IRS Web site at IRS.gov or by calling the IRS forms and publications order line at 800-829-3676.

If you need assistance in obtaining past returns, please give our office a call.

The IRS recently announced they will be stepping up their tax return audits after several years of heavy reliance on correspondence audits. Their mission is to help fill the tax gap. The areas of increased audits include Schedule Cs (sole proprietor businesses) where the Treasury Department estimates income is underreported by an estimated $68 billion.

An IRS tax audit can come in a number of forms. The most demanding are the face-to-face audits, which require sitting down with an auditor and reconciling income and deductions.

Others are the less demanding correspondence audits where the IRS has reason to believe that the taxpayer failed to include reported income or has overstated deductions.

Face-to-Face Audits – Self-employed, high-income taxpayers, those who have omitted substantial income, or those who repeatedly fail to show income to support their lifestyle are more likely to be subject to these types of audits. Some are simply random to provide the IRS with statistics for targeting the most fruitful audit results.

You can appear for the audit yourself, but that is probably a bad idea since you are not trained in the rules and regulations regarding audit procedures and what limits the IRS’s incursion into your private life. You can authorize your tax professional to handle it without you. Often, this is the best way to prevent the audit from escalating beyond the original areas that attracted the IRS's interest in the first place. Practitioners experienced with IRS audits are less likely to become emotional or to make statements that would lead to additional IRS questioning.

Correspondence Audits – Employers, banks, lending institutions, schools, brokerage firms, escrow companies and others all feed data to the IRS, which the IRS, in turn, matches by computer to the information reported on your tax return. If there is a significant discrepancy, the IRS will correspond with the taxpayer. Sometimes these discrepancies will result in additional tax liability, while other times a simple explanation will satisfy the IRS and make the problem go away. Here are some examples of typically-encountered discrepancies:

• Unreported Retirement Income – Whenever a taxpayer takes money out of one IRA account and rolls it over within the 60-day statutory limit into another IRA or qualified plan, the income is not taxable. The IRS will know about the withdrawal but not the subsequent rollover, and unless the rollover is reported on the tax return, the IRS will believe it to be a taxable distribution. So what would have been a simple entry on the tax return results in a correspondence audit. When moving an IRA from one institution to another, making arrangements for a direct transfer will generally avoid these types of audits.

• Gross Proceeds of Sale – Generally, when real estate, stock or marketable securities are sold, the IRS knows what you sold and for what price. Thus, you must account for the sale on the tax return and compute the gain or loss. If you omit reporting the transaction, the IRS will treat the entire sales price as profit, adjust your tax, and notify you via a correspondence audit.

• Alimony Paid or Received – A taxpayer who pays alimony is able to deduct the amount he or she paid. On the other hand, the recipient of that alimony must report that amount as taxable income. The IRS checks to make sure the amounts match. If they don’t, expect a notice in the mail.

• Home Mortgage Interest – Each of your mortgage lenders will report to the IRS the interest paid on your mortgage for the year and issue you a Form 1098 for the same amount. If these amounts don’t reconcile, expect a notice or a request for an explanation. This is frequently an issue when the loan is from a private party not reporting the interest to the IRS, or when more than one individual is on the loan but the 1099 only has space for one Social Security Number (SSN). In both cases, the IRS provides a procedure for dealing with these issues on your tax return. However, if the procedure is not followed, the IRS will be unable to verify interest paid under your SSN and will issue a notice or request an explanation.

• Tuition Paid – Because of the education tax credits that can be claimed for paying tuition to a qualified higher education institution, the IRS requires those institutions to report the tuition received to the IRS and issue Form 1098-T to the student. Thus, the IRS has the ability to verify the tuition paid during the year, and any mismatch could result in a correspondence audit.

• Interest and Dividends – The IRS allows many financial institutions to issue substitute 1099s, i.e. forms that are not in the standard 1099 format. These substitute forms—with various types of interest and dividends reported separately and spread throughout lengthy annual account statements—can often be misinterpreted by an untrained eye. To make matters worse, many brokerage firms have issued amended 1099 statements late in the tax filing season because of errors in allocating the investment income by the proper type. Incorrectly reported, erroneously reported, or omitted investment earnings can trigger correspondence from the IRS.

• Non-Taxable Interest – Interest from municipal obligations are tax-free for purposes of computing federal tax. However, tax-free municipal interest income is added to income for purposes of computing taxable social security income and determining whether a taxpayer qualifies for earned income credit (EIC). Thus, all tax-free municipal interest must be reported on the tax return or risk a subsequent inquiry from the IRS.

• Cash Contributions Beginning in 2007 – Beginning for the 2007 tax year, regardless of the amount of cash contributed, the contribution must be backed up with either a bank record or written communication from the donee organization showing the: (1) name of the donee organization, (2) date of the contribution, and (3) amount of the contribution. The recordkeeping requirements may not be satisfied by maintaining other written records.

What this means is that unless the charitable organization provides written communication, cash donations put into a “Christmas kettle,” church collection plate, and pass-the-hat collections at youth sporting events will not be deductible. Donations by debit or credit card can be substantiated by bank records. These new rules will give the IRS the ability to audit taxpayer’s charitable contributions via correspondence audits since all contributions must be backed by a written receipt or bank record.

Don’t assume that just because you received a notice that the IRS is correct. They are frequently wrong. Please call this office before responding to any IRS notice. Tax laws are complicated, and the notices are not always easily understood.

Caution: It is strongly recommended that you contact this office immediately upon receipt of any inquiry from the IRS or state tax agency. Don’t procrastinate, because that only leads to further action on the part of the IRS or state agency.