Tightened rules make it harder to deduct auto
donations
You’d never know it by the continued solicitations by charities for vehicle
donations, but the IRS has cracked down on the tax deduction you can take for
your old jalopy. Applying to motor vehicles, boats and airplanes, the rules
divide vehicles into two classes — those valued at $500 or less and those with
values over $500.
How to value vehicles
For lower valued vehicles, the amount of the deduction is equal to the item’s
fair market value. The IRS doesn’t say how the fair market value must be
assigned, though the wholesale price as listed in Kelley Blue Book or a similar
publication is often a good guide. No appraisal is required.
Vehicles worth more than $500 are subject to a more stringent standard. The
value assigned must be equal to the charity’s gross proceeds when it sells the
vehicle in an arm’s-length transaction without making significant improvements
to it.
Typically these vehicles are sold at auto auctions at prices less than those
found in pricing guides. In such cases, the charity must generally provide the
donor — within 30 days of the sale — a Form 1098-C (or equivalent) that includes
the price received for the donated vehicle. The donor must attach the form to
his or her personal tax return to claim the deduction. The charity also is
required to supply this information to the IRS.
Different rules for vehicles going to needy
If the purpose of the donation program is to provide transportation to the needy
by selling them vehicles at significantly below-market values, the charity can
provide you with an acknowledgment indicating that you may claim a deduction
equal to the fair market value of the vehicle.
If you’re considering donating a vehicle yet this year, don’t delay. The
donation must be claimed for the year that the vehicle was donated. But because
it can’t be claimed until after the charity has sold the vehicle and sent the
acknowledgment, this could delay filing your tax return.
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Just when you got used to
Windows XP
A new Vista is on the horizon
After a five-year hiatus, Microsoft is readying a new
operating system to replace Windows XP. Look for Microsoft
to begin shipping “Vista” to personal computer (PC) makers,
businesses and home users in the near future.
If you use Windows, Vista is likely to have a major impact
on your business — sooner or later you’ll need to move to
the new operating system.
Enhanced security at the forefront
For business users, enhanced security features will be the
most compelling. They include:
- A more sophisticated
firewall,
- Built-in antispyware and
antiphishing capabilities,
- Stronger user account
control, and
- Network access
protection.
Some versions will also
include hard drive encryption. Some of these capabilities
are available today as add-on, third-party utilities, but
costs should be lower and support easier when they’re
packaged with the operating system. Internet Explorer will
also get a makeover: Vista plugs many of the security holes
the product has been known for.
You can take it with you
Mobile users will benefit from Vista’s mobility center,
because it’ll allow them to control many aspects of their
laptops from a common interface. The “Sync Center” will
enable users to synchronize their laptops with desktop PCs
and networked systems.
Vista’s new “Aero Glass” user interface includes transparent
and animated windows, plus a three-dimensional task
switcher, much like what Macintosh users enjoy. Finally, the
“Sidebar,” a control window located on the side of the
screen, contains “Gadgets,” one-click utilities that
automate various tasks, such as printer or wireless access.
A flavor for every taste bud
While XP variations were limited, Vista will have at least
five “flavors”:
1. Home Basic is designed for entry-level PCs and has
fewer features.
2. Home Premium includes the Aero interface, more
multimedia features and basic networking.
3. Business will have the Aero interface, more
networking capabilities and remote administration features.
4. Enterprise, for large companies, adds hard drive
encryption and sophisticated remote administration
capabilities.
5. Ultimate combines all the multimedia, networking,
security and remote administration capabilities into one
package.
Some of the advanced components may also be sold separately
and added to more basic systems as needed.
Current hardware may not be adequate
Many PCs won’t be able to run Vista. Although PCs purchased
within the last few years should have a fast enough
processor, they may not have enough memory or sufficiently
sophisticated graphics capability.
According to Microsoft, Vista will require at least 512 MB
of memory. To take full advantage of the advanced features,
you’ll need at least 1GB of memory and an
advanced graphics card. These requirements will add to the
cost of the typical PC, something to keep in mind for all
new system purchases even if you don’t plan to migrate to
Vista soon.
Tech support to continue
Microsoft usually offers full support for older operating
systems for two years after a replacement is released. This
includes security updates, other critical updates and
telephone support. Business versions receive an additional
three years of more limited support.
So, XP Home Edition customers can count on their system
being maintained for two years and those using XP
Professional should be able to receive critical security
updates for at least five years.
This is just the beginning
Vista launches a major upgrade cycle for Microsoft’s core
applications. A new version of the network operating system,
codenamed “Longhorn,” is being developed. And “Office 2007”
is also forthcoming.
If your business relies on networked computers, carefully
plan your Vista migration strategies. If installed
correctly, Vista has the potential to both increase your IT
security and lower your system administration costs.
Don’t be in too much of a hurry, though. Most experts advise
letting others work out the bugs of new operating systems.
If you can, wait a year before your company takes the
plunge.
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Shredding personal records
With year end rapidly approaching you may be cleaning
through records wondering what to save and what to toss.
Here are some general guidelines to help you determine which
records you must hold on to. Before you start, check with
your tax and legal advisors. If you don’t, you may get rid
of something you really need to keep.
|
Personal records |
1 year |
3 years |
7 years |
Permanent |
|
Bank statements and deposit slips |
|
|
X |
|
|
Brokerage statements (year end),
investment purchase and sale records, mutual fund
annual statements, and dividend reinvestment records |
|
|
X* |
|
|
Brokerage and mutual fund
statements (monthly and quarterly) |
X |
|
|
|
|
Credit card statements |
|
|
X |
|
|
Estate planning documents |
|
|
|
X |
|
Home improvement records
(canceled checks, receipts, etc.) |
|
|
X* |
|
|
Home purchase documents |
|
|
X* |
|
|
Insurance policies (other than
life) |
|
|
X** |
|
|
IRA and retirement plan documents
and statements |
|
|
|
X |
|
Legal documents |
|
|
|
X |
|
Life insurance policies
|
|
|
|
X |
|
Loan records/Forms 1098 |
|
|
X* |
|
|
Medical bills (insurance-related) |
|
X |
|
|
|
Medical bills (tax-related) |
|
|
X |
|
|
Medical records |
|
|
|
X |
|
Paycheck stubs (until you
reconcile them with your W-2) |
X |
|
|
|
|
Tax returns |
|
|
|
X |
|
Tax return supporting documents
(canceled checks, receipts, charitable contribution
documentation, etc.) |
|
|
X |
|
|
W-2s and 1099s |
|
|
X |
|
*After ownership
period or loan term ends
**After policy
expires
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Last of the red-hot export
incentives?
Businesses can use the IC-DISC to cut their tax bills
The repeal of the extraterritorial income exclusion (EIE)
has renewed interest in a little-used export incentive: the
interest-charge domestic international sales corporation
(IC-DISC). Privately held companies with significant export
sales can use an IC-DISC to slash their tax bills — and, for
some, the tax savings will even exceed the benefits
available under the EIE.
IC-DISC makes a comeback
Since the early 1970s, the U.S. government has tried to help
American companies compete abroad by offering tax breaks for
exporters, such as the domestic international sales
corporation, foreign sales corporation and EIE. But the
World Trade Organization and European Union have challenged
every one, calling them illegal export subsidies.
In response, the United States passed the American Jobs
Creation Act of 2004, which phased out the EIE between 2004
and 2006 while phasing in a new deduction for “domestic
production activities” (also known as the manufacturers’
deduction) from 2004 through 2010. Once it’s fully phased
in, the deduction will effectively reduce the top corporate
income tax rate for qualifying producers from 35% to 32%.
The repeal of the EIE has sent exporters looking for
alternatives. A key reason the IC-DISC is being viewed as an
attractive one is the Jobs and Growth Tax Relief
Reconciliation Act of 2003, which reduced the maximum tax
rate on qualified dividends from 20% to 15% through 2008.
More recently, the Tax Increase Prevention and
Reconciliation Act of 2005 extended the reduction through
2010.
By making tax-deductible “commission” payments to an
IC-DISC, an exporter can convert large amounts of ordinary
income — taxable at rates as high as 35% — into dividend
income taxed at 15%.
Eligibility
An IC-DISC is a tax-exempt “paper” corporation set up to
receive commissions on export sales. If the exporter is an S
corporation, limited liability company or partnership, it
can form an IC-DISC as a subsidiary. C corporation exporters
must have individual shareholders (usually the exporter’s
shareholders) set up the IC-DISC to realize the tax
benefits.
In addition to being a U.S. corporation, an IC-DISC must
satisfy a number of technical requirements, such as:
- Elect to be treated as
an IC-DISC for tax purposes,
- Maintain a minimum
capitalization of $2,500,
- Have a single class of
stock,
- Meet a 95% qualified
export assets test, and
- Meet a 95% qualified
gross receipts test.
To pass the qualified gross
receipts test, at least 95% of the IC-DISC’s gross receipts
must consist of commissions related to qualified export
property — that is, property:
1. Manufactured, produced, grown or extracted in the United
States,
2. Held primarily for sale, lease or rental for direct use,
consumption or disposition outside the United States, and
3. Whose value is not more than 50% attributable to imported
materials.
Although the exporter must actually transfer cash
commissions to the IC-DISC, the IC-DISC isn’t required to
have separate offices or employees or perform any services.
As far as the exporter’s customers are concerned, the
IC-DISC is invisible.
Tax savings
An exporter is permitted to
pay commissions to an IC-DISC up to the greater of 4% of its
gross receipts from sales of qualified export property or
50% of its net income on those sales. The exporter deducts
the payments, but the IC-DISC is exempt from tax on the
commission income.
The IC-DISC has the ability to defer tax on up to $10
million in commission payments in exchange for modest
interest payments to the IRS (hence the “interest charge” or
“IC” designation). Most important, commissions distributed
to the exporter or individual shareholders are treated as
dividends and taxed at the 15% qualified dividend rate.
For example, EXP Inc., an S corporation, earns $1 million in
net income on $15 million in qualifying export sales. EXP
forms an IC-DISC as a subsidiary, paying it a $600,000
annual commission (4% of $15 million).
EXP deducts the $600,000 commission payment, avoiding
$210,000 in ordinary income taxes (assuming the highest 35%
rate). When the commissions are distributed as dividends
from the IC-DISC, its shareholders pay a 15% tax — or
$90,000. By forming an IC-DISC, EXP saves $120,000 a year in
federal income taxes.
Don’t let it slip by
It’s possible the European Union will challenge the IC-DISC,
though many experts view that as unlikely because it isn’t
available to large publicly traded corporations.
Even if a challenge is brought, it could be several years
before the dispute is resolved, so take advantage of this
export incentive’s low cost and potentially significant tax
savings while you can.
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A GRAT way to transfer a
family business
There are many estate planning techniques available to help
you transfer your family business to the next generation at
a low tax cost. For a pass-through entity that generates
strong, predictable cash flow, the grantor retained annuity
trust (GRAT) is a great tool to pass business interests to
family members free of gift and estate taxes.
How you benefit
A GRAT is advantageous because it allows you to receive an
annuity for a specified number of years and, at the end of
the term, the remaining assets are transferred to your
beneficiaries. Depending on the trust terms, the annuity
amount is either a fixed percentage of the trust property’s
initial fair market value (FMV) or its FMV at a subsequent
time. Because a GRAT is a “grantor trust,” you pay income
taxes on the trust’s earnings.
As long as you outlive the trust, the assets remaining in
the trust at the end of the trust term are removed from your
estate and sheltered from estate taxes. If you don’t survive
the trust term, the assets will be brought back into your
taxable estate.
How it works
When you transfer assets to a GRAT, you make a taxable gift
to the trust’s beneficiaries. The amount of the gift is the
present value of your beneficiaries’ remainder interest.
Present value is determined using the Section 7520 rate,
which is the IRS presumed rate of return on the GRAT assets.
By setting the annuity payments high enough so that their
present value is equal to the value of the trust assets, you
can reduce the gift amount to zero. To the extent that the
trust assets outperform the Sec. 7520 rate, however, the
additional appreciation passes to your beneficiaries free of
estate tax.
How you save
Let’s say you’re the sole shareholder of an S corporation
that has an FMV of $15 million and distributes $2 million
per year in dividend income. You transfer 40% of the stock
to a 10-year GRAT for the benefit of your daughter. Assuming
a 30% minority interest valuation discount, the FMV of the
transferred interest is $4.2 million ($15 million x 40% x
70%).
Suppose you create the GRAT in a month when the Sec. 7520
rate is 6%. For a 10-year GRAT, an annuity of just under
13.59%, which generates a required annuity payment of
$570,545, will result in zero gift tax. But the 40% interest
is expected to earn $800,000 per year in dividends. If those
dividends are generated, and as long as you survive the
10-year trust term, the GRAT will transfer the 40% interest
in the business plus the difference between the dividend and
annuity payments — more than $2.25 million — free of gift
and estate taxes.
It’s important for the business interest to generate enough
cash flow to cover the annuity payments. If it doesn’t, the
GRAT will have to return a portion of the business interest
to you, diminishing the tax benefit.
GRAT expectations
In light of recent IRS attacks on family limited
partnerships and other estate planning techniques, the GRAT
may be one of the most effective tools for saving taxes
while transferring a family business. Fortunately, designing
a GRAT that will pass muster with the IRS is relatively
simple.
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