Category: Taxation

Man Evaluating Property

Proposed Treasury Regulations Aim to Reduce Valuation Discounts on Family Gifts

Significant Changes for Family Gifts

On August 4, the Treasury Department issued proposed regulations under Internal Revenue Code Section 2704 that, if enacted, would significantly limit the applicability of valuation discounts to certain intra-family transfers.

Gift and Estate Tax Implications

In many cases, this limitation would prevent individuals from discounting the value of gifts of real property or business interests made to the individuals’ family members, causing the individual to use more of his or her gift tax exemption amount when making lifetime gifts.

Likewise, the proposed regulations would significantly limit the use of valuation discounts when calculating the size of the gross estate of a decedent, thereby increasing the value of the estate for estate tax purposes and the amount of estate tax payable.

Public Hearing in December

The public hearing on the proposed regulations will not be held until December 1, 2016, and thus the regulations will not become final this year.  Although we believe it is unlikely that the regulations will become final in their present form, we do expect that regulations limiting the availability of valuation discounts for certain intra-family transfers will become final – probably in 2017.

Explore Gifts in 2016 vs. 2017

For that reason, if you are considering making a gift of an interest in real property or a business, we suggest that you at least explore the option of doing so in 2016, rather than waiting until 2017 when the tax results may be less favorable to you.

Audit Featured Image

What to Expect from an IRS Audit

What every taxpayer should know regarding types of IRS audits and common issues that can trigger audit.

An audit is an investigation into a tax return of an individual, business, estate or trust.  The IRS uses this process to determine if the information provided in the tax return is correct. This article discusses three types of audits and several common audit triggers.

Types of IRS Audits

Correspondence Audit

This is the most common type of audit and also the easiest in terms of what is required and the length of time involved.  Usually the IRS will send a request for supporting documentation to prove deductions, exemptions, proof of dependents, proof of charitable donations or other documentation to corroborate a specific part of the return.  This is the least stressful form of audit for the taxpayer and usually sending in the requested paperwork is enough to satisfy the IRS.   It is strongly advised that you seek the help of an experienced tax attorney to prepare your reply to the IRS correspondence audit and to ensure the documentation you send is exactly what is needed.  As long as a response is made within the timeframe and the documentation enclosed satisfies the proof needed by the IRS, the audit is complete.  This type of audit is most commonly utilized for individual tax returns, where there are perhaps one or two simple issues the IRS wants you to substantiate.

 Office Audit

An invitation to appear at an IRS office to conduct an office audit is a serious matter.  It is important you do not attend the office audit without your tax attorney.  Being asked to an office audit means the IRS is counting on the possibility that you owe additional taxes.  It is essential that you seek the advice of an experienced tax attorney to accompany you to the IRS office audit to protect your rights and to use their knowledge and experience to assist you in finding ways to reduce or eliminate any additional taxes.

Field Audit

A field audit is the most serious form of audit and involves an IRS Auditor coming to your place of business to thoroughly audit your records.  If the IRS finds that your business has inaccurately reported income and evaded paying the correct tax, the consequences could result in heavy penalties, additional taxes and possible prison time.  It is of utmost importance to engage the services of an experienced tax attorney to be present while the IRS auditor is at your place of business.

Below is a summary of common audit triggers

Large amount of charitable donations

The IRS looks closely at the receipts and proof of your charitable donations.  If your charitable donations are more than 3% of your income, the IRS will scrutinize your documentation.  Make sure you have receipts, cancelled checks, and appraisals for all donations to substantiate your claim for deductions.

Failing to report part of your income

The IRS already knows what is on your W-2 and 1099s in terms of income.  If you do not report your income accurately on your tax return, this will likely trigger an audit.  You will receive a W-2 from your full-time job, but may also receive 1099s for freelance work you do on the side, as well as other forms of miscellaneous income, in all cases you must report all of your income from all sources.

Large losses on Schedule C, or many years of losses on Schedule C

If you are self-employed, and report your income on a Schedule C, you will report either a profit or a loss.  If your return shows a very large business loss on a Schedule C, or if you have a history of several years of losses on your Schedule C, this will likely attract IRS attention.

The reason behind this is that the IRS likes to see a profit at least two out of five years to consider a business legitimate.  If there are five years of losses reported on a Schedule C, the IRS will likely audit to see if ‘hobby’ would be a better description.  This is important because taxpayers are required to report any income earned from a hobby, but tax payers generally cannot deduct losses.

For example, a Professional Photographer with his own business, clients, advertisements, portfolio etc., can claim as a business expense the purchase of a camera.  Whereas, a doctor who enjoys taking photographs during his weekend hikes cannot claim a new camera as a business expense.

Claiming too many business expenses

In addition to the business/hobby issue just discussed, reporting too many losses can also cause the IRS to question how your business is staying solvent.  If you report many personal expenses through your business without it being a true necessary business expense (in order for your net profit to decrease and therefore your tax liability to decrease) the IRS will scrutinize your records during an audit.

Random Selection

Unfortunately, even if you do everything right, there is always a small (less than 1%) chance that your return will be randomly selected for an audit.

In Conclusion

If you do receive an audit notice from the IRS, it does not need to be the start of a stressful and difficult time for you and your family, or your business.  You will likely benefit from an experienced tax attorney’s advice and direction with the protection of the attorney client privilege.

1040 Tax Form

Tax Season is Here – The Advantages of Hiring a Professional Tax Preparer

The Advantages of Hiring a Professional Tax Preparer

Even the words ‘Tax Season’ can be enough to give anyone a headache!  Fortunately, you do not need to face tax season alone.  Hiring a tax professional can be invaluable to you especially if your situation has recently changed or is complex.

Federal tax law is adjusted every year, making it difficult for an average taxpayer to keep up to date with all the changes, and to understand how to apply these changes to their own tax situation.

A professional tax preparer works hard to keep up to date with all adjustments to tax law, both federal and state, making it advantageous to the taxpayer to hire someone with such an accurate knowledge base.

Deductions and Credits

With extensive knowledge and experience, a professional tax preparer will be able to assist you in finding little known deductions or credits, that you may be unaware you qualify for.

Where you may be eligible for several deductions and/or credits, and yet only be allowed to use one, your tax preparer will have the knowledge to accurately calculate which deduction and/or credit would be the best choice to minimize your tax liability.

IRS Audit

Facing an IRS audit alone can be tremendously difficult and stressful.  If you are audited, it might be tempting to answer the IRS yourself. It is strongly recommended that even the initial response to an IRS audit inquiry come from a tax attorney.

You can communicate confidentially with a tax attorney before the response to the IRS is prepared to give you the best chance of a “no change” letter from the IRS at the conclusion of the audit.

Filing Status

Did you get married or divorced in the past year?  Did you have a child?  Adopt?  Or have you recently lost your spouse?  These changes in situation can dramatically change your filing status and exemptions, deductions and credits you may be entitled to.

If you are a widow(er) your status may change not only for the year in which you lost your spouse, but for a specific time period after.  Determining the best and most tax advantageous filing status takes special knowledge of tax law and time-sensitive dates.

Your professional tax preparer would be able to determine the best way forward.

Child in College?

Is your child in college?  Your tax preparer can assist you in determining how to claim your child under the age of 24, if they are still in full-time education.

Determining how to properly claim older children, especially if they have income either in the form of wages or investment income, requires in-depth knowledge of ever-changing tax law.

Real Estate

If you have bought or sold any real estate, or have invested in rental property, a tax professional can assist you to make the most of the credits and interest deductions available to you.

If your home or property has been affected by a fire, flood, earthquake or other natural disaster, your tax preparer can assist you to take advantage of relief provisions and elections with regard to replacement property and any gain or loss incurred.

Starting a New Business

Starting a new business is an exciting time for anyone, however there are tax implications that can be difficult to understand.  A tax preparer will help you navigate the complex world of business deductions, expenses, insurances, how to properly report your income, accurately calculate self-employment tax and paying estimated taxes.

If you have started a new business, large or small, it would be wise to seek professional tax advice and assistance in preparing your taxes to ensure accuracy and to take advantage of your tax preparer’s knowledge to utilize all allowable deductions and credits to minimize your tax liability.

Summary

Indeed, hiring a Professional Tax Preparer to prepare and file your taxes, will ease the stress and burden of tax season, and leave you with peace of mind and confidence in your financial future.

Estate Tax Form Pencil

A Look at History:  The Estate Tax Exemption Really Has Increased

In a post earlier this year, we discussed that Americans can now transfer more than $5 million dollars in assets through the estate tax system without incurring a tax, while at the same time permitting their beneficiaries to receive those assets with a new and usually higher “stepped-up” basis.

Addressing the concept gave rise to the question:  Given inflation over the years, is the estate tax exemption really higher than it has been historically?  In order to answer that, we created a table showing the estate tax exemption over time, comparing it to the current buying power of the exemption amount in 2015 dollars.

While the comparisons are not perfect because the tax laws have changed over the years, the chart illustrates that the current exemptions are, indeed, historically high.

Throughout most of the twentieth century, the buying power of the exemption amount hovered at around $500,000 measured in 2015 dollars. The exemption’s 2015 equivalent started creeping up in 1990, but did not reach the $5,000,000 range until 2011. (The basic outline of the gift and estate tax laws has been consistent since the early 1980s.)

As noted in the earlier post, the exemption amount has been historically-high for several years.  There are no signs that it will be reduced in the near future.  It is clearly time to consider free basis when making estate planning decisions.

Tax Year                               Estate Tax Exemption                          2015 Equivalent

1920                                          $50,000                                                     $585,805

1930                                          $100,000                                                  $1,406,000

1940                                          $40,000                                                     $562,000

1950                                          $60,000                                                     $584,000

1960                                          $60,000                                                     $476,000

1970                                          $60,000                                                     $363,000

1980                                          $161,000                                                  $459,000

1990                                          $600,000                                                $1,078,000

2000                                          $675,000                                                  $920,000

2001                                          $675,000                                                  $895,000

2002                                          $1,000,000                                             $1,305,000

2003                                          $1,000,000                                             $1,276,000

2004                                          $1,500,000                                             $1,864,000

2005                                          $1,500,000                                             $1,803,000

2006                                          $2,000,000                                             $2,329,000

2007                                          $2,000,000                                             $2,264,000

2008                                          $2,000,000                                             $2,180,000

2009                                          $3,500,000                                             $3,829,000

2010                                          Unlimited

2011                                          $5,000,000                                             $5,217,000

2012                                          $5,120,000                                             $5,234,000

2013                                          $5,250,000                                             $5,290,000

2014                                          $5,340,000                                             $5,295,000

2015                                          $5,430,000                                             $5,430,000

 

Estate Tax Image

There is a Free Lunch – Rethinking Your Relationship With the Estate Tax System

Americans have been trained to fear the US Estate Tax system, sometimes called the death tax system.

However, now that a single person can transfer more than $5 million through the estate tax system without paying a tax, the time has come for us to change our way of thinking.  We need to change our thinking because the estate tax system includes a hidden gift that is now extremely valuable.

The gift is this:  Assets that pass through the estate tax system receive a new basis, which is the value of the asset on the date of death.  Given the number of assets that have increased in value over the course of the past 40-50 years, the new basis at death is frequently an increased “stepped up” basis.

To begin at the beginning, the tax basis of an asset is generally the price that a taxpayer paid for the asset.  The tax basis is important, because it is the measuring point for determining a taxpayer’s gain or loss on disposition of the asset.  So, if a taxpayer paid $1.00 for a share of stock, then sells it for $10.00, the taxpayer’s gain is $9.00, and the taxpayer has to report that gain and pay a tax on it.

The lesson is: The higher an asset’s basis, the better.

The problem is that basis increases generally are not free.  For example, if a person owns a rental property, he or she can increase basis by spending money on the property with the addition of a capital improvement.  The basis adjustment is the direct result of spending money.

Historically, the basis adjustment that is available through the estate tax system – like other basis adjustments – came with a price tag.  The property was subject to estate tax and it emerged from a painful taxation system with a new basis because it had generated a tax payable to the IRS.

Now, though the estate tax exemption is so high that people can use the estate tax system to acquire something that was inconceivable not so long ago: free basis.

The logic to free basis:

  1. The price of the basis adjustment at death has been the need to expose the asset to the estate tax system and the consequent need to pay an estate tax at high rates.
  2. Now, though, the estate tax exemption is so high that many people can expose their entire fortunes to the estate tax system without paying any tax, and many can do this without even filing an estate tax return.
  3. Since Congress did not change the basis adjustment rules when it changed the exemption amounts, the assets that go through the estate tax system painlessly (and perhaps without even filing a return) still receive a basis increase at no cost, which equals free basis.

The key underlying lesson to learn from the current situation is that – even if you cannot look at the US Estate Tax system as a friend – you can look at the system as a neighbor you need to learn to live with.

A few ideas to help you take advantage of free basis:

  1. Historically, parents have given assets that were likely to appreciate to children, so that the appreciation would not be exposed to the estate tax system at the parent’s death. However, when the gift was made, the parent’s basis would transfer to the child, and would not be stepped-up at the parent’s death.  This made sense when the estate tax system imposed a price.  Now that the system does not impose a price for most people, it makes sense for the parent to hold the asset until death so that it can be transferred to the child with a free basis increase.
  1. You probably have a natural aversion to taking money from your IRA, because you pay income tax on your withdrawals. However, if your aversion to taking money from your IRA were to cause you to sell an asset to pay tax at the capital gains rate, you might reconsider.  The assets in the IRA will not get a basis increase when you die.  The capital asset outside the IRA will get a basis increase.  Your situation might be improved by taking money from the IRA and leaving the capital asset on hand so that it can be eligible for free basis.
  1. Think twice before making annual exclusion gifts with anything but cash.
  1. Don’t get involved with family limited partnerships and fractional interest discounting unless you are rich enough to really need them.
  1. Recognize that a traditional A/B Trust may result in the loss of a stepped-up basis at the death of the second spouse. While an A/B Trust can still make good sense for family reasons (especially dealing with a blended family), you should be sure that the trust has been modified to provide a method for obtaining an increased basis. The attorneys in our firm are adept at accomplishing this without disrupting family dynamics.