Grossbach Zaino & Associates, CPA's, PC


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How To Prevent Tax Losses from Washing Away

You sold one of your stock investments at a profit, so now you’ll have to report a capital gain on this year’s income-tax return. Since another stock you own has been losing ground lately, you’re thinking of selling it to claim a capital loss on your return to offset your gain.

However, because you believe the company will bounce back eventually, you’re reluctant to part with your stock. What would happen if you sold your stock to claim the loss and then bought it back again right away?

Perfect Plan?

At first glance, it might appear to be the perfect plan. But it won’t work because of the tax law’s wash-sale rules. These rules prevent you from claiming a capital loss on a securities sale if you buy “substantially identical” securities within 30 days before or after the sale. If you want to claim the loss, you’ll have to wait more than 30 days to repurchase stock in the company.

Gone for Good?

Wondering what happens to wash-sale losses you can’t deduct? They don’t just disappear from your tax calculations. Instead, you’re allowed to add the losses to the cost basis of the shares you reacquire. This increase in cost basis will mean a smaller capital gain (or a larger loss) when you eventually sell your shares.

Potential Trap

Keep track of any share purchases you make through a stock dividend reinvestment plan or by having mutual fund distributions automatically reinvested. Selling shares of the same stock or mutual fund at a loss within 30 days of the automatic purchase (before or after) will trigger the wash-sale rules, and part of your loss will be disallowed.

Plan B

Is there any way you can take your tax loss and still maintain your position in the stock? Consider doubling up on the loss securities, then wait 30 days and sell your original securities at

a loss.


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Keeping Shareholder Loans Businesslike

A common way for a shareholder to withdraw tax-free cash from a closely held corporation is to borrow money from it. For such a tax strategy to pass muster with the IRS, however, the loan must be businesslike. The IRS has issued an audit guide on shareholder loans that describes factors that determine whether withdrawals will be considered loans or taxable dividends.

A BONA FIDE LOAN?

Whether or not a disbursement to a shareholder will be considered a loan for tax purposes depends on whether, at the time of the distribution, the shareholder intended to repay it and the corporation intended to require repayment. “Yes” answers to the following questions can help demonstrate this intent.

  • Did the shareholder provide security for the loan?
  • Is the shareholder in a position (as to salary, other income, and net worth) to repay the loan?
  • Did the shareholder give a certificate of debt to the corporation?
  • Is there a repayment schedule or an attempt to repay?
  • Is there a set maturity date?
  • Does the corporation charge interest?
  • Does the corporation make systematic efforts to obtain repayment?
  • Is there a ceiling on the amount the corporation can advance?

Loans that aren’t considered bona fide may be reclassified as dividends — taxable to the shareholder and nondeductible by the corporation. “Yes” answers to the following questions would indicate that distributions to a shareholder may be constructive dividends rather than loans.

  • Does the shareholder control the corporation’s affairs?
  • Were large advances made to a controlling shareholder whose ability to repay is contingent on future events?
  • Does the corporation have adequate earnings and profits with respect to the advances made, coupled with no history of paying dividends?

The above list is not all-inclusive. No factor by itself is determinative; the factors are viewed as a whole. Professional tax advice can help you arrange a shareholder loan that will satisfy IRS scrutiny.


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Year-end Income-tax Planning

As 2014 winds down, consider some of the following suggestions for saving on your taxes — both this year and in 2015.

Pay Fourth Quarter Estimated State Taxes Early

Taxpayers who itemize on their federal returns may deduct any state income taxes paid during 2014. Paying fourth quarter estimated taxes (generally due in January) by the end of 2014 can increase tax savings. However, this strategy may not benefit taxpayers subject to the alternative minimum tax (AMT).

Increase Retirement Savings

Employees enrolled in retirement savings plans may, prior to year-end, increase their pretax contributions, which would decrease taxable income. For 2014, employees may make contributions to their 401(k), 403(b), and 457(b) retirement plans of up to $17,500, plus an additional $5,500 for those 50 and older. (Additional plan limits may apply.)

For 2014, the limit for deductible contributions to an individual retirement account (IRA) is the lesser of compensation or $5,500, and individuals 50 and older may contribute an additional $1,000.

Even if a spouse has no earnings, he or she may make a contribution if the working spouse has sufficient compensation to cover their combined IRA contributions. Note that the deduction for IRA contributions may be limited if you (or your spouse) are covered by a retirement plan at work and your adjusted gross income exceeds certain limits.

Take Required Minimum Distributions (RMDs)

Generally, individuals 70½ or older who have IRAs or retirement plan accounts must take their RMDs before the end of the calendar year. Failure to do so may result in a 50% penalty on withdrawals not taken. Taxpayers who turn 70½ in 2014 may wait until April 1, 2015, to take their first RMD. However, this decision should be considered carefully since a second RMD will have to be taken before the end of 2015, and the two RMDs may considerably increase taxable income for 2015.

Minimize the 3.8% NII Tax

Higher income taxpayers will have to pay an extra 3.8% surtax on the lesser of (1) net investment income (NII) or (2) the amount by which their modified adjusted gross income exceeds certain thresholds ($250,000 for joint filers or surviving spouses, $125,000 for those married and filing separately, and $200,000 for single and head-of-household filers). Planning opportunities for reducing NII include increasing contributions to qualified retirement plans, transforming passive business activities into active business activities, deferring capital gains through the use of installment sales, and eliminating capital gains with offsetting capital losses.

Please contact us if you’d like to discuss your tax situation.


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Documenting Business Expenses

Most ordinary and necessary business expenses are deductible as long as you have the proper documentation. If your return is audited, the IRS may require that you show the type of item purchased and that payment was made. Here are some examples of acceptable documentation.

 Checks. A canceled check can be used as proof of payment if it has the name of the payee and shows the cancellation on the back. The IRS also accepts highly legible images of checks if you don’t have your checks returned.

 Credit/debit card transactions. You must have an account statement that shows the amount of the charge, the transaction date, and the name of the payee.

Electronic funds transfers. The IRS requires an account statement that shows the amount of the transfer, the date the transfer was posted to the account by the financial institution, and the name of the payee.

Invoices. You must have an invoice or some other form of documentation showing what you purchased. Canceled checks, credit/debit card statements, and records of electronic funds transfers only provide proof of payment.

Cash register receipts. If you receive a receipt with no details of the items purchased, write a description of the items on the slip. As long as the purchase is for a relatively small amount, the IRS should accept it.

If it’s not self-explanatory, make sure you write the business reason for your purchase on the invoice or receipt so you’ll be prepared for any questions from the IRS. And be aware that there are separate substantiation rules for travel, entertainment, and auto expenses.


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Elder Care Tax Breaks

If you’re paying for the care of an elderly parent or relative, you may be able to take advantage of several tax provisions that could help you recoup some of your expenses.

 

Dependency Exemption

 

Generally, you may claim a dependency exemption ($4,000 in 2015) for an individual if you provide more than 50% of the individual’s support costs and the individual:

  • Lives with you or is related to you
  • Does not have gross income exceeding the exemption amount
  • Does not file a joint return
  • Is a U.S. citizen or a resident of the U.S., Canada, or Mexico

The exemption is phased out for higher income taxpayers.

Medical Expenses

 

If you pay medical expenses for your dependent parent (or other dependent relative), you may include those expenses with your own for tax deduction purposes.* The deduction may also be available if your parent or relative fails to qualify as your dependent because of the gross income and/or the joint return test listed above. Medical expenses include the qualifying long-term care costs of a “chronically ill” individual.

 

Dependent Care Credit

 

Additionally, you may be entitled to a tax credit for a portion of any costs you incur for the care of your parent or relative that enables you and your spouse to work. Your parent or relative must live with you and be unable to care for himself/herself.

* Medical expenses are deductible to the extent they exceed 10% of your AGI (or 7.5% of AGI if you or your spouse is 65 or older).


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Don’t Even Think About It

There is zero wiggle room when it comes to handling the federal income taxes and FICA taxes withheld from employees’ paychecks. The taxes are government property, which employers hold “in trust” and then remit to the IRS on a set schedule. Employers are not permitted to use this “trust fund” money for other purposes.

Serious Penalty

The penalty for breaking the rules is harsh. Any person involved in collecting, accounting for, or paying the trust fund taxes — a “responsible person” — who willfully fails to do so may be liable for a penalty equal to 100% of the unpaid taxes. The penalty is aggressively enforced.

Responsible Persons

Generally, a responsible person is anyone with the power to see that the taxes are paid. This might include a corporation’s officers, directors, and shareholders; employees; and the partners in a partnership. Under certain circumstances, even family members and professional advisors may be subject to the penalty.

It’s not uncommon for there to be more than one responsible person. When that’s the case, each responsible person could be found liable for the full penalty.

A Word About Willful

Failure to pay trust fund taxes can be willful without being an intentional attempt to evade paying the taxes. Temporarily “borrowing” from the trust fund to meet bona fide business expenses in a pinch can qualify as being willful.