News On The Tax Front--The latest tax news.
Stock Valuation Reduction Allowed--With estate tax rates of 50% or more, any decrease in the value applied to your company, the better. Here's how a taxpayer won a reduction.
Thinking of Investing in a Small Business? --"Angels" help finance many small businesses. The result can be rewarding, but it's also risky. Here are some tips to reduce that risk.
Ignoring Employees Can Be Expensive --Ignoring employee complaints can generate lawsuits, or make them worse.
In Brief:--Tax, business, and personal finance tips.
Previously Reported In Daily Update
Don't think you can escape an assessment or tax lien if the IRS makes a clerical error. In Charles A. Reid, Jr. (2000-1 USTC 50,340; U.S. District Court, So. Dist. Ga.) the Court held that the taxpayer's assessments were not eliminated by credits mistaken made to his account. The Court held the IRS could still foreclose on his property.
The tax law provides for many special elections that can be made. For example, relinquishing the required carry back of a net operating loss to only carry it forward. In most cases making the election will reduce your tax liability. But, in most cases, the IRS requires you to make the election within a certain time limit. Often, it's by the time you file your tax return, including any extensions. In Irene H. Dzuris (2000-1 USTC 50,348; U.S. Court of Appeals, Federal Circuit) the Court disallowed the taxpayer's election to use 10-year averaging on a lump-sum distribution because the election was not timely made.
The IRS allows certain entities, notably LLCs and partnerships, to make a special election to be treated as corporations. The rules are known as the "check-the-box regulations." The IRS has just announced that, in response to public comments, it will modify the regulations in final form so as to clarify certain sections.
If you're going to claim losses related to an S corporation, you've got to be able to document those losses. In Daniel J. Culnen (T.C. Memo. 2000-139) the taxpayer could not do so. Some of the assets sold were subject to liens, so the amount realized from their sale should have been increased by the amount of the liens.
In order to claim head of household status for filing, you've got to prove you have a dependent. In Jean Claude Guerrier (T.C. Memo. 2000-140) the taxpayer could not show he provided a domicile and the required support to a child he considered his foster child.
How much substantiation is necessary to insure a deduction? Unfortunately, it often depends on the circumstances. The IRS may accept may accept minimal support or it can require you to prove every item with a canceled receipt (how much they can demand can depend on the type of expense). In Daniela Aldea (T.C. Memo. 2000-136) the Court did not accept diary entries of charitable contributions that indicated the dollar amount as proof the contributions were made.
In the same case as above (Daniela Aldea; T.C. Memo. 2000-136) the taxpayer was denied mileage deductions for travel to work sites. The Court found that since she did not work in a single metropolitan area on a normal basis. Thus, the locations were not temporary since they were not outside the metropolitan area where she normally worked and lived.
In another hobby loss case, the Tax Court noted that the taxpayer maintained no records and had not consulted with experts concerning his auto drag racing activities. His income was nominal and were minimal when compared to his losses and the total investment in the activity. It didn't help his case that he derived personal pleasure from the activity and he used the losses to offset other income. Alton F. Emerson; T.C. Memo. 2000-137.
A couple who did not keep adequate records had their income reconstructed by the IRS. The Tax Court sided with the IRS. The taxpayer claimed to be an agent and that he resold auto parts at no profit. The Court found his testimony unconvincing, particularly in light of significant profits on prior returns. Michael Vetrano and Patricia Vetrano; T.C. Memo. 2000-128.
Vermont may have passed a same sex marriage law, but the IRS hasn't accepted same sex partners as able to file married. The Court held the partners could not file as married. Robert D. Mueller; T.C. Memo. 2000-132.
Just because you spend a considerable amount of time at an activity won't automatically insure that it will be recognized as a business. In Anthony J. McCarthy (T.C. Memo. 2000-135) taxpayer managed his son's motorcycle racing activity. The Court found the personal satisfaction outweighed the considerable time and effort he spend on the project. The expenses were disallowed as a hobby loss.
In Internal Revenue News Release IR-2000-25 the IRS announced that, through April 9, 2000, the IRS web site has recorded 791 million hits, a 15% increase over last year.
What's the tax treatment of a lump-sum payment to employees to buy out their right to receive annual payments from a productivity fund? In a recent technical advice memorandum (TAM 200013035) the IRS held that the payments were fully taxable as compensation to the employees.
You may not agree with the tax laws, but claiming you're not subject to the laws can be costly. In Daniel Franklin Haines (T.C. Memo. 2000-126) the taxpayer filed unsigned and undated returns, and even those he filed late. Because he refused to cooperate in the discovery process of the case and continued to make frivolous arguments, the Tax Court assessed him a $25,000 penalty.
Think the IRS is kidding about supplying a social security number for your children on your tax return? In Thomas W. Furlow, Jr. (2000-1 USTC 50,324; U.S. Court of Appeals, 4th Circuit) the Appeals Court sided with a District Court and disallowed a dependency exemption when the taxpayer did not supply a social security number. The fact that he attached an affidavit was not relevant.
You file your tax return and some time later the IRS sends a letter requesting more information. You ask your accountant to handle it. Unless there is a power of attorney on file, your accountant can't do much for you. That's about to change. In Internal Revenue News Release IR-2000-23 the IRS announced that beginning with the 2001 filing season, paid preparers, with their clients' permission, will be allowed to work directly with the IRS to resolve tax return processing issues. Taxpayers can identify through a checkbox on Form 1040 returns an individual paid preparer to serve as a designee to resolve processing related matters. A power of attorney will still be needed for examination matters, collection notices, etc.
The IRS and the courts are not sympathetic to either inadvertent or deliberate mistakes when it comes to qualified pension plans. One of the punishments frequently meted out is disqualification of the plan. That's what happened in the case of Howard E. Clendenen, Inc. (2000-1 USTC 50,316; U.S. Court of Appeals, 8th Circuit). The Court found that contributions to the plan on behalf of the taxpayer's president exceeded the limitations in Code Sec. 415(c)(1).
If you've filed a refund claim with the IRS and the refund is denied, you've only got a limited amount of time to file a suit if you want to fight the IRS in court. That's what the Court said in Arthur E. Marcinkowsky (2000-1 USTC 50,320; U.S. Court of Appeals, Federal Circuit). The Court held the taxpayer did not file the suit within 2 years from the date the IRS mailed him a disallowance notice.
The budget surplus seems to be increasing every time it's recalculated. That bodes well for a tax increase this year. The President has indicated he will veto the Republican tax cuts, but that may be posturing and/or he could be forced to pass at least some tax cut bill.
If you're considered a responsible party for payroll tax purposes you can't delegate away that responsibility. That's what the District Court held in JoAnn Dvorak (2000-1 USTC 50,313; U.S. District Court, Dist. Minn.). Not only that, the Court noted that she was aware that the corporation had withheld payroll taxes but had not deposited them with the IRS, but was paying other creditors. The Court found her personally responsible for the withheld taxes.
If you don't have good records, the IRS can reconstruct your income. When it does so, it usually wins when challenged in court. Courts are generally unsympathetic to the taxpayer. However, in Theron R. Livingston, Sr. (T.C. Memo. 2000-121) the Court found that the Service's reconstruction was so poor that he through out the assessment.
Whether or not you can deduct legal fees can depend on the reason on why the fees were incurred. In Sharon Purcell DiLeonardo (T.C. Memo. 2000-120) the taxpayer had to pay attorney's fees that trustees incurred in defending themselves in a lawsuit she brought against them in connection with the accounting for a trust in which she was a beneficiary. The Court reasoned that the fees were ordinary and necessary in connection with her attempt to secure more money from the trust.
We've mentioned before that the most advantageous filing status is often head-of-household. However, to do so you must be unmarried and have a dependent. And the IRS has a strict definition of unmarried. In Keith Chiosie (T.C. Memo. 2000-117) the Court found the taxpayer was still living in the same house as his estranged wife. The fact that they were not sharing the same bedroom was irrelevant. The only filing status that was available to him was married, filing separate (the worst filing status).
Contributions to a college, parochial school, etc. can be deductible as a charitable contribution--but not if the payments are in lieu of tuition or result in some special treatment. In Michael and Marla Sklar (T.C. Memo. 2000- 118) the Court found the taxpayers' payments were not deductible because they were really tuition for their children.
At one point it looked like the marriage penalty bill stood a good chance of quick passage. The bill has now stalled in the Senate at least partially as a result of amendments by Democrats.
The IRS announced that a new income tax treaty with Denmark entered into force on March 31, 2000. The new treaty replaces the one signed in 1948.
In another cash vs. accrual accounting argument, the Tax Court held that a taxpayer that purchased and then delivered sand and gravel to construction sites of its customers had to use the accrual method of accounting. The merchandise was an income- producing factor and the taxpayer was primarily in the business of selling sand and gravel. The service of transporting the sand and gravel was incidental. Von Euw & L.J. Nunes Trucking, Inc. T.C. Memo. 2000-114.
Stock Valuation Reduction Allowed
Even if the estate tax elimination bill passes, the tax won't pass into history immediately but will be phased out over as long as 10 years. And, until that time, any reduction in the valuation put on your company's stock in your estate can result in substantial tax savings. For every dollar decrease in value, you could save over 50 cents in tax. Or, $100,000 valuation reduction could provide $50,000 in tax savings.
Built-in gains tax. First, some background. A regular corporation can be taxed twice on any gain from the sale of an asset. Once at the corporate level and again at the shareholder level. An S corporation generally escapes tax at the corporate level. That can result in some big tax savings. That could be a loophole in the law. Why not operate as a C corporation and, if you have to sell an asset that has appreciated, for example, when corporate assets are sold or when the corporation is liquidated, convert to an S corporation before the asset sale? Congress recognized the loophole and closed it by creating the "built-in gain" rule. Basically, if a C corporation elects to be an S corporation, the gain on any property that has appreciated in value from the date of purchase to the time the S corporation election is made is a built-in gain. That built-in gain will be subject to a separate tax. The "taint" expires at the end of 10 years from the time the S election is effective.
Estate tax valuation. In the case of Estate of Pauline Welch, Deceased; Neton G. Welch, Jr.; Lois Welch McGowan, Co-Executors (85 AFTR2d Par. 2000-534; No. 98-2007) Pauline Welch died holding a minority interest in two closely held corporations. The estate applied a 34% discount to the stock's value to reflect the built-in gains tax on the real property held by the corporation. The Tax Court disallowed the discount. The taxpayers took their case to the Court of Appeals.
The Court of Appeals said that, in a prior case (Eisenberg) the court recognized that the valuation should be based on a "hypothetical willing buyer, having reasonable knowledge of the relevant facts, would take some account of the tax consequences of contingent built-in capital gains . . . in making a sound valuation of the property." Thus, if you were buying the stock of a corporation that had assets subject to the built-in gain rule, you wouldn't want to pay as much for the stock since you'd have to pay the special tax on the sale of those appreciated assets. You may not discount the value by the full amount of the tax if there was only a short time left, say one year, to run on the 10-year period.
In this case the IRS argued that the taxpayer could avoid the tax by simply not selling the assets. The Court countered with the fact that it's not important whether the shareholders will sell, distribute or liquidate the property, but what a hypothetical buyer would take into account in arriving at the fair market value of the stock. The IRS argued further that the corporation might be able to avoid current taxation by making a like-kind exchange of the property with another party. Again, the Court found that it didn't make any difference that the corporation could use this technique. It still comes back to what a willing buyer would pay.
The Court concluded that while the estate may not be entitled to deduct the full amount of the potential liability, particularly in the absence of any expert testimony to support such a discount, the estate should be given the opportunity to present evidence of the appropriate amount that the hypothetical willing buyer and seller would consider as a discount or adjustment in the value of the corporations' stock.
Discounts. The built-in gains tax is 35%. Thus, theoretically you might reduce any valuation by 35%. However, the Court (and common sense) would suggest that the discount would be somewhat less. How much? It could depend on a number of factors. To be sure, the closer to the end of the 10-year period, the less the discount should be. Talk to your tax advisor about your particular situation. But even a lesser discount, say 25%, would be substantial on a $100,000 valuation. And, don't forget, this isn't the only discount available. There can be a discount for marketability and one for a minority interest (a minority interest isn't worth as much as a controlling interest because the shareholder wouldn't be in control). The combined discounts available can easily exceed 50%.
In any valuation situation you need good advice. Your attorney or accountant can help, but may recommend getting a professional appraiser. You want to take advantage of all discounts and factors that would reduce the valuation, but you don't want to reduce the claimed value to the point where you'll incur penalties.
Thinking of Investing in Another Small Business?
Individuals who advance venture capital money to small businesses are often called "angels." We're talking about an investor who loans money or makes an equity investment in an unrelated small business. Generally, the term applies to investors who didn't start the business and who don't have family members in the business. However, in this article we'll broaden the definition to include investing in businesses owned or run by family members or close friends. Such investments can be extremely rewarding, but they also involve a high degree of risk. Here are some points to consider before writing the check.
Does it make sense economically? You take a risk even when investing in a big, public company. However, no matter how volatile a stock is in the market, if you see it going lower you can always sell out at the market. In a risky stock in a volatile market, you could lose a significant portion of your investment, but more than likely you'll be able to come away with a good part of your investment. That's not true when investing in a small, local company. You may not be able to sell out. Your investment should be such that you can afford to lose all of it.
We've often heard "it doesn't matter, I can use the tax writeoff." That makes no sense. If you invest $10,000 and lose it all, your tax savings, at most, may be $4,800. And that assumes you're in the top bracket (39.6%) for federal purposes and your state taxes are close to 10%. More than likely, both rates will be lower. Assuming an overall rate of 40%, with a $10,000 loss, you'll be out $6,000. It could be worse. For a number of reasons, those losses may not be deductible immediately. That makes them even less valuable.
We won't go into all the factors to consider when investing in a small business. If you're a sharp financial type and/or good businessman, you shouldn't have too much trouble evaluating the enterprise. But it might make sense to ask your CPA for advice. Any amount you pay should be worth it. Here are some other thoughts:
Using operating losses. While the income and losses of an S corporation, partnership, or LLC are passed through to the owners, that doesn't mean you're automatically entitled to deduct your share of the operating losses on your personal tax return. There are three tests you have to meet. Satisfy all three and you can deduct the losses against other income. Fail any one of them and the losses aren't currently deductible, but can be carried forward to a time when the required test(s) are met or you have offsetting income. There's no similar rule for income. It's always reportable.
The first test involves your amount at risk. You can only deduct losses up to your amount at risk. That is, if there's no real risk of an economic loss, any equity investment or loan is not truly at risk. For example, you put up $50,000 in equity capital, but one of the other partners has agreed to pay you back should the investment go sour.
The second test concerns your basis. See our articles in the September 15, 1999 and March 1, 1999 issues for complete details. Basically, you can only deduct losses up to your basis in the equity investment and loans made to the business. Your basis is equal to your initial investment increased by any profits of the business and additional investment or loans and decreased by losses and distributions to you.
While it's possible to run into problems with the first two tests, the material participation test is the one that is most likely to cause a problem. Basically, if you don't materially participate in the business, any income or loss is passive and you can't deduct the amount directly on your return. You can only use it to offset other passive income for the year, or the amount can be carried forward for use in a year when you do have passive income. While there's a $25,000 exception to this rule for passive income from real estate rentals, that doesn't apply here.
What is material participation? In order to be considered materially participating you've got to be more than an investor, you've got to be involved in the day-to-day management of the business. Thus, simply reviewing financial and monitoring the business in a nonmanagerial capacity doesn't qualify. The IRS has 7 tests. Pass any one of them and you're considered to be materially participating for the year. Some of the tests won't apply. Here are the ones you might be able to pass.
Tax Tip--Be advised, IRS agents are taught to test for material participation if they're doing an audit of a taxpayer where losses from an S corporation, partnership, or LLC are involved. You would be wise to keep a record of the time you spend working on the activity. You might be able to do so with a diary, appointment book, etc.
What if you can't use the losses? You can keep accumulating them until such time as you have passive income that can be offsetting. What if you never have passive income? You can claim the accumulated losses against ordinary income when you sell, dispose or abandon the investment because it becomes worthless. However, you must have basis and be at risk in order to do so.
Tax Tip--If you have accumulated losses but insufficient basis when the investment is disposed of, you lose the ability to take those losses. Talk to your tax adviser. You may have other options.
Equity investment versus loan. Most investors automatically assume the best way to invest in a small business is through a loan. That may not be true. There are a number of tax and business considerations that should be evaluated before making a decision.
First, look at the realities of your investment. Unless you have a loan secured by equipment, real estate, etc. the security of holding debt instead of equity probably isn't there. When many small businesses have financial difficulties, the company has so much debt that there is little left for any bondholders in a liquidation. If the company is starting off with a heavy debt load, its financing options are reduced. There are also negative tax implications for corporations with a high debt to equity ratio.
Second, any loan you make to the company is almost sure to be viewed as a nonbusiness loan. Losses on such loans are considered capital losses for tax purposes. That means any deduction is limited to offsetting capital gains or $3,000 per year of ordinary income. Moreover, you can't just claim a loss on your return because you think the loan is bad. You've got to show you've made an effort to collect. And, in general, you can't claim a partial loss--it's all or nothing.
Tax Tip--If you're going the loan route, make sure you have a formal note (see our Forms section), you get regular interest payments, the loan is recorded on the company's books as such, etc. You don't want the IRS saying the loan was really an equity investment, which it can do if the transaction is not handled properly.
Third, in the case of a corporation (C or S) you should take advantage of Section 1244 stock. Basically, if the qualifications are met, you can write off up to $100,000 of your stock investment in any one year, against ordinary income. For example, you put $90,000 into the stock of Madison Inc., a C corporation. After 3 years Madison closes its doors and your investment proves worthless. You can write off the entire $90,000 against your other income for the year. Check with your tax advisor to be sure your investment will qualify.
Things get more complicated in the case of a partnership or LLC that's taxed as a partnership. For one thing, the benefits of Section 1244 stock aren't available. For another, there are a number of special rules that apply to partnerships. Check with your tax advisor.
On any substantial investments in a small company, you should check with your tax and financial advisors before making any commitments.
Loans to relatives. If the business is owned by a relative, there's another potential problem in making a loan. If the business goes sour, you're going to be in a tricky position. If you want that tax deduction, you're going to have to show you tried to collect on the debt. That may be tough to do. And if you don't try hard enough, the IRS will argue that the amount advanced was really a gift and you'll get no deduction. It gets worse. If you get a deduction, the debtor will have forgiveness of debt income. Thus, he'll have taxable income, probably at the worst possible time.
Loan guarantee. You may be asked to guarantee a loan a bank or other lender makes to the business. You should look at this as if the loan proceeds were coming out of your own pocket, because they may well be if the company defaults. You may decide you don't want to be liable for a $100,000 loan.
In some cases you and some other investors may sign as "jointly and severally" liable. That means the lender can go against all of the guarantors or just one of them, usually the one with the most resources. You could find yourself liable for the full amount of the loan even though a number of other investors signed the guarantee. The results may be similar if you guarantee or sign personally on a lease of real property.
From a tax standpoint, you'll get no writeoff for signing a guarantee. Only if you have to make good will you have a deduction, and then only a nonbusiness bad debt.
Control. If you're investing a substantial amount in the business, and are becoming a significant stockholder or owner, you should consider being able to gain control of the corporation if current management proves to be less than competent. You don't want a good idea going sour because of poor management. Check with your attorney on what can be done.
Personal liability. The main reason for doing business as a corporation is that the shareholders are protected from the liabilities of the corporation. A shareholder can't lose any more than his equity investment. That's also the general theory behind an LLC. It's not true of a partnership. The general partners can be held jointly and severally liable. (Limited partners in a limited partnership are protected.)
But there are still situations in which you could find yourself liable. If you're a director, you could be held liable for certain acts. You could also be liable if the corporation or LLC isn't operated according to the law and a court considers it the "alter ego" of the shareholders or members. And you could find yourself liable for any undeposited withholding taxes or unpaid sales taxes. Check with your attorney on the rules.
Borrowing to finance investment. If you've got to borrow money to finance the investment, you should really consider whether you should be making it. Investing in small companies is very risky.
In addition, from a tax standpoint borrowing may not make sense. If the business is a C corporation, the interest expense will be considered investment interest. You can deduct such interest on your personal return up to the amount of your investment income. Investment income includes mostly interest and dividends. Thus, if you have $5,000 of interest and dividend income you could deduct a like amount of interest expense (if it qualifies as investment interest as it would in this case). Interest expense in excess of that amount could be carried forward and deducted in a future year, subject to the same limitation.
The rules are different when it comes to an S corporation or partnership. If the investment is nonpassive (e.g., you materially participate in the activity) you can deduct the interest without any limitation. If the investment is passive, your interest deductions will be limited to the passive income.
Do such investments make sense? As we said above, investing in small companies can be extremely risky. While venture capitalists generally look for an overall rate of return of much more than 35% annually, they often do so by scoring big on just a few of their investments. The rest often turn out to be lackluster or losers. And they've got the time, energy and skill to select winners and make them work.
Given all the negatives, should you invest? While the risk is great, the rewards can be too. The return can be far greater than the average investment. That may be even more true in the future since the stock market is unlikely to provide returns similar to those of recent years. Not only that, the investment can be more rewarding than a book entry at your broker.
Here are some final thoughts:
Ignoring Employees Can Be Expensive
You may or may not be an enlightened employer and considerate of your employees, but in this age of litigation and government regulation, the quickest way to get yourself into trouble is to ignore the complaints of employees. That's sure to accomplish two things--tick off the employee(s) and set you up for a lawsuit where you've given away your best defense. Complaints such as :
should be dealt with seriously.
What action should you take? It depends on the complaint. If the employee is complaining of a job-related injury or sickness, send him to the doctor. If there is a problem, you may be able to nip it in the bud. If the employee is faking, the prospect of a doctor's visit could stop any complaints. If there is a problem that the doctor doesn't discover, at least you've done your part.
In many cases, just listening to an employee's complaint may be enough to satisfy him or her. For example, many sexual harassment cases might never have gone to trial if the employer had taken the situation seriously and taken some sort of action to prevent a recurrence. Treating an employee's complaint lightly is sure to provoke additional action or generate permanent ill will.
In many cases listening to the employee can be beneficial for the company. A complaint of noises in equipment could be a warning of an imminent breakdown. Or the employee might have a suggestion on how to reduce his backstrain. That in turn might improve overall productivity.
You may need professional help--a lawyer's advice in the case of sexual harassment, a doctor for injuries, an environmental engineer for EPA violations, etc. If you call for professional help when first advised of a problem, you'll bolster your case should you end up in court.
By the way, firing a person accused of sexual harassment could set you up for a wrongful dismissal suit. Check with your attorney.
Previously Reported In Daily Update
Resale certificates . . . If you're required to charge sales tax on your sales and sell to resellers, you're probably required to have a resale certificate on file for those purchases, or you're required to charge tax. Many states allow both single use and blanket certificates. A blanket certificate means you don't have to request a resale certificate for every sale. But the life of a blanket certificate varies from state tot state. In Massachusetts they're valid indefinitely; in Connecticut they have to be renewed every three years. Check the rules in the states you do business in. Even if a certificate doesn't expire, it's a good idea to check your files regularly and request a new certificate every 3 years. You don't want to get caught if you're audited.
Proof of filing . . . If you owe money with your return or you want proof you sent in an election or other important form, you should send it either by certified or registered mail (or one of the designated private delivery services). Be careful. Don't use US Postal Service Certificate of Mailing (Form 3817). The IRS has said it will not accept this form as proof of mailing.
Break on next order . . . Instead of giving a discount on the current order, consider giving a discount, free item, etc. on the next order. It won't work all the time, but often you'll be able to generate much more business.
Disaster loss election deadline extended . . . You can elect to deduct a loss attributable to a disaster occurring in a presidentially declared disaster area in the prior year. Thus, you can elect to deduct a loss occurring in 2000 on an amended 1999 return. However, you must make the election by the due date of the return, including extensions, for the year the loss occurs. In a recent letter ruling (LR 200006037) the taxpayer's tax preparer, because of a misunderstanding, failed to make the election on time. The IRS allowed the taxpayer another 45 days to make the election.
Annual beneficiary check . . . Make a list of all your beneficiaries and check it annually. Unless you're unusual, you'll probably find at least one will have to be changed each year--more as you get older. Check insurance policies, your will, IRAs, pension plans, etc. If you haven't reviewed the status of this assets in several years, talk to your attorney, tax and/or financial advisor.
Smaller estate may require new will . . . On more than one occasion we've mentioned that you should revise your will regularly to take into account, among other things, an increase in the size of your estate. But a revision is also important if your estate decreases in size. For example, large gifts to heirs or other relatives, gifts to charity, a significant shrinkage in value of your assets, etc. Gifts to heirs may mean that you may not want to leave them as much on your death. The same goes for gifts to charity. But just as important, often there are specific bequests in wills that require distribution before other heirs share in the residuary. If that's the case and your estate is smaller, the distribution of your assets may be markedly changed from your intentions. You should also revise your will if the form of your assets change. For example, you may want to leave your vacation home to your daughter, but decide to sell it when offered a good price. More importantly, you want to take advantage of the special benefits for business owners, but, because of changes in the make-up of your estate, no longer can. Check with your attorney. Most will rewrite your will for a small fee.
Spendthrift provision in trust . . . You may want to provide for a son or daughter who are no longer minors, but still aren't (or will never be) qualified to handle their own financial affairs. The simplest solution is to set up a trust. There are no big tax benefits here, just a steady income for your children. Don't forget to include a spendthrift provision in the trust. That will prevent them from anticipating receipt of trust income and assigning the right to receive the income to creditors or others before it's distributed to them. That applies to older beneficiaries as well as minors.
Mutual fund performance . . . You don't have to be a close follower of the market to know that stocks have been extremely volatile in the last few months. Many funds are still advertising their performance using figures through March 31, 2000. Results since then may have been much worse. One high- tech fund was up over 120% last year, but fell over 50% during the one-month period after the NASDAQ peak. Picking the best fund based on performance numbers is particularly difficult with a high-tech fund since much of the fund's value may be concentrated in a few stocks. But even in more diversified funds the numbers can be misleading. Best advice? Don't look solely at results for the quarter, year to date, or even one year. See how the fund has done over 3, 5 or 10 years. In order to pass muster the fund doesn't have to have beaten the averages over that time period, but you should be suspicious if it's consistently and significantly underperformed in comparison to its peers. It could mean recent results are a fluke brought on by an outstanding showing of just a few stocks in the fund.
Nonresident alien employees . . . Do you have any nonresident alien employees? If so, check the rules on withholding of federal income taxes. These employees are generally not exempt from withholding. In fact, you may have to withhold at a higher rate than on U.S. citizens because they generally cannot claim the standard exemption. If the employee wants to avoid being underwithheld, he or she should mark the W-4 as single, even if married, and claim only one withholding allowance. Residents of Canada, Mexico, Japan and Korea may fare better. For more info, see IRS Publication 15.
Extension to adjust basis in partnership property . . . When a shareholder purchases an interest in a corporation, he or she is simply buying shares representing an ownership interest in the corporation. Thus, it doesn't make any difference that an asset may have been purchased by the corporation for $100 and now worth $100,000--or vice versa. The rules can be somewhat different for a partnership. If a partner buys an interest in the partnership or a partner leaves, the partnership can make a Section 754 election to adjust the basis of assets. Normally the extension must be made with a timely filed (by the due date, including extensions) tax return for the year involved. In letter ruling LR 200013014 the IRS granted the partnership an extension of time to file.
Copyright 2000 by A/N Group, Inc. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is distributed with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional should be sought. The information is not necessarily a complete summary of all materials on the subject.--ISSN 1089-1536