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Apr 11

IC-DISC can save Privately Held Manufacturers Income Tax on Exports

By Paul Oliveira, CPA

Do you manufacture products in the United States for export to foreign countries? Is your company privately held? Then you might be eligible for a significant tax-saving opportunity: the interest charge–domestic international sales corporation (IC-DISC).

An IC-DISC is a tax-exempt corporation you can establish to receive commissions on export sales. The IC-DISC’s shareholders typically are the same as the exporters’ but can include family members or key employees.

The maximum commission is the greater of 4% of gross receipts from sales of qualified export property or 50% of net income on those sales. The exporter (i.e., your current operating company) can deduct the commissions paid to the related IC-DISC. Because the IC-DISC is tax-exempt, the commissions aren’t taxed until they’re paid out to the IC-DISC shareholders in the form of qualified dividends. In the meantime, the operating company has generated a business deduction for the commissions paid.

Put another way, the IC-DISC allows the exporter to convert ordinary income (currently taxable at rates as high as 39.6%) into qualified dividend income (currently taxable at rates as high as 23.8%, including the 3.8% net investment income tax). This provides permanent tax savings of 15.8%.

An IC-DISC may provide deferral benefits as well. The exporter can defer tax on up to $10 million in commissions held by the IC-DISC (that is, not distributed to the shareholders) in exchange for modest interest payments to the IRS. Other IC-DISC benefits include:

  • Higher return on investment without any operational changes
  • Increased liquidity for shareholders
  • Wealth-shifting opportunities for estate planning purposes
  • Ability to reward key employees in a tax-efficient manner
  • An IC-DISC doesn’t have to have assets, office space or employees. But it must maintain proper records separate from those of the exporter.

    If you produce products in the United States that you export — including to Canada or Mexico — you might benefit from an IC-DISC. But many factors must be considered to determine whether you’ll qualify and, if so, whether you can reap sufficient benefits to warrant setting one up. For assistance assessing whether an IC-DISC could be right for your company, please contact Paul Oliveira, CPA, or any member of the KLR International Tax Services Team.

    Interested in manufacturing abroad? Learn more about our Doing Business in China Series.

     

    Apr 3

    Have Foreign Accounts? The Latest IRS FATCA Regs could Increase your Penalty Risk

    By Neelu Mehrotra, MST, MSPA, EA

    In February, two new sets of IRS regulations were released that affect the Foreign Account Tax Compliance Act’s (FATCA’s) implementation. FATCA requires foreign financial institutions (FFIs) and U.S. taxpayers to report certain information about U.S.-owned foreign financial accounts.

    The new regs generally apply to FFIs; however, increased FFI reporting could make it more likely that undisclosed foreign accounts held by U.S. taxpayers will be identified by the IRS, potentially subjecting these taxpayers to significant back taxes, interest and penalties if the income earned and accounts were not disclosed.
     
    Under FATCA, U.S. taxpayers holding foreign financial accounts are required to file Form 8938, “Statement of Specified Foreign Financial Assets,” with their income tax return if the aggregate value exceeds one of the following thresholds:

    • $50,000 ($100,000 for married couples filing jointly) at the end of the tax year, or
    • $75,000 ($150,000 for joint filers) at any time during the tax year.

    Noncompliance can be costly: The penalty for failing to file the form is $10,000, with added failure to file penalties up to $50,000. Additional penalties can include underpayment penalties of up to 40% of the amount of the underpayment. A fraud penalty can also be imposed of up to 75% of the amount unreported. 

    U.S. holders of foreign accounts could also be subject to Financial Crimes Enforcement Network (FinCEN) reporting requirements — at a much lower threshold: aggregate foreign account value exceeding $10,000 at any time during the calendar year. Account holders subject to the requirements must file Form 114, “Report of Foreign Bank and Financial Accounts (FBAR),” with FinCEN by June 30 of the following year.

    Failure-to-file penalties can be high. A person who is required to file an FBAR and fails to properly do so may be subject to a civil penalty not to exceed $10,000 per violation. A person who willfully fails to report an account or account identifying information may be subject to a civil monetary penalty equal to the greater of $100,000 or 50 percent of the balance in the account at the time of the violation. In addition, there can be criminal penalties of up to $250,000 or five years in jail or both.

    Also be aware that you could be subject to certain requirements without being the actual account owner. They may apply to you if, for example, you have signatory authority over an account.
    The requirements surrounding foreign financial account reporting are complex. If you think you might be subject to them, please contact us for additional information. We can help you comply with and understand the rules and avoid, or at least minimize, costly penalties.

    Mar 20

    Impact of the Health Care Law on your 2015 Tax Return

    By Loree Dubois

    There are a few basic tips to keep in mind about the new health care law and your health insurance choices. Your decisions now will have an affect on the income tax return you file in 2015.

    1. Many people already have qualified health insurance coverage and the law will not require them to take any other action other than to maintain their qualified coverage throughout 2014.
    2. If you do not have health insurance through your job or a government plan, you may be able to buy it through the Health Insurance Marketplace- HealthSourceRI In Rhode Island.
    3. If you purchase your insurance through the Marketplace, you may be eligible for an advanced premium tax credit to lower your out-of-pocket monthly premiums.
    4. Your 2014 tax return will ask if you had insurance coverage or qualified for an exemption. If not, you may owe a shared responsibility payment when you file in 2015.

    A shared responsibility payment refers to the individual mandate tax and applies to everyone, including children and seniors. Generally the payment would be either a percentage of your household income or a flat dollar amount, whichever is greater. This payment went into effect on January 1, 2014 and applies to any month (1/12th of the annual payment for the months you do not have coverage) in 2014 that you were either not covered or qualified for an exemption. Once this is fully phased in (estimated by 2016) the individual mandate tax will be $695 per uninsured person or 2.5 percent of household Income over the filing threshold.

    If you or your family does not have health insurance, talk to your employer about the coverage they offer, or visit The Marketplace online.

    Mar 13

    Key Expired Tax Breaks for Businesses

    By Paul Oliveira, CPA

    This is a continuation of our previous blog: Scorecard of the Key Expired Tax Breaks for Individuals but for businesses.

    Research and Development Credit- Business are no longer eligible for a long-standing tax break for increasing qualifying R&D expenditures (QREs), including wages, supplies, and certain consulting and contract research fees related to qualified research activities. In 2013, this credit generally equaled 20 percent of the amount by which current-year QREs exceeded a base-period amount (subject to a 6.5 percent maximum).

    50 Percent First-Year Bonus Depreciation Deduction- For qualifying new (not used) assets that were placed in service (hooked up and ready for use) in calendar year 2013, taxpayers could write off 50 percent of the cost in the asset’s first year of service. Qualifying assets included most software, certain “heavy” passenger vehicles, non-passenger vehicles, and equipment.

    Expanded Section 179 Deductions- For tax years that began in 2013, eligible small and medium-sized businesses could immediately write off up to $500,000 of qualifying new and used assets, including most software, certain “heavy” passenger vehicles, non-passenger vehicles, equipment, and up to $250,000 of qualifying real estate improvements. Assets had to be placed in service (hooked up and ready for business use) by the end of the tax year that began in 2013 to be eligible.

    The maximum Section 179 deduction for tax years beginning in 2014 will be only $25,000. And no Section 179 deductions will be permitted for real estate improvements.

    15-Year Depreciation for Leasehold Improvements, Restaurant Property, and Retail Space Improvements- Generally, taxpayers must depreciate non-residential real property straight-line over 39 years for federal tax purposes. But 15-year straight-line depreciation was allowed for the cost of qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail space improvements that were placed in service in 2013 (but not expensed under Section 179 or eligible for the 50 percent first-year bonus depreciation deal in 2013).

    New Markets Credit- In 2013, individuals and corporate taxpayers could receive a federal tax credit for qualified equity investments in certain community development entities. Examples of projects that might qualify for the credit include small business financing and daycare centers improvements in low-income communities. In 2013, the credit generally equaled 39 percent of the qualified equity investment and could be claimed during a seven-year credit period.

    Credit for Building Energy- Efficient Homes- In 2013, homebuilders were eligible for a $2,000 tax credit for each new energy-efficient home they built in the United States, including manufactured homes. Firms could also claim this credit for substantially reconstructing and rehabilitating an existing home and making it more energy efficient. Homes that did not fully meet the energy-efficiency standards could qualify for a reduced $1,000 credit. A home had to be sold by December 31, 2013 for use as a residence to qualify for the credit.

    Credit for Manufacturing Energy- Efficient Appliances- The credit for manufacturing energy-efficient dishwashers, clothes washers, and refrigerators in the U.S. expired at the end of 2013. The credit amounts per unit were $75 for qualifying dishwashers, $200 for qualifying refrigerators and $225 for qualifying clothes washers.

    Business Credit for Alternative Fuel Vehicle Refueling Property- In 2013, businesses could claim a federal tax credit for up to 30 percent of the cost of installing non-hydrogen alternative fuel vehicle refueling property. This credit could be claimed for expenditures such as a gas station’s costs to install ethanol, compressed natural gas, or hydrogen refueling pumps or equipment to recharge electric-powered car batteries. For businesses, the annual cap for each location for this credit was $30,000. A credit for hydrogen refueling property is allowed through 2014.

    S Corporation Built-In Gains Tax Exemption- If you operate a corporation that recently converted from C to S status, a corporate-level built-in gains tax (also known as the BIG tax) may apply when certain S corporation assets—including receivables and inventories—are converted to cash or sold within the “recognition period.” The recognition period is normally the 10-year period that begins on the date when the corporation converted from C to S status.

    For eligible built-in gains that were recognized in tax years beginning in 2013, however, there was an exemption from the BIG tax. The exemption applied if the fifth year of the S corporation’s recognition period had gone by before the start of the tax year that began in 2013.

    Enhanced Charitable Deduction for Food Donations- Businesses that were not operated as C corporations were entitled to an enhanced charitable contribution if they donated food to qualified charities in 2013. This provision was intended for non-C corporation businesses that have food inventories, such as restaurants and grocery stores. These deductions are normally limited to the taxpayer’s basis in the food or its fair market value, whichever is lower. But in 2013 the temporarily enhanced deduction equaled the lesser of:

    • The taxpayer’s basis in the food plus one-half the value in excess of basis or
    • Two times the taxpayer’s basis in the food

    The same enhanced deduction rule has been available to C corporations for years – and still is. The taxpayer’s total charitable contribution deduction for food donations under this provision generally could not exceed 10 percent of net income for the tax year from sole proprietorships, S corporations, or partnerships (or other non-C corporation entities) from which the food donations are made.

    Favorable Rules for C Corporation Farm and Ranch Qualified Conservation Contributions- Qualified conservation contributions are charitable donations of real property interests, including remainder interests and easements that restrict the use of real property. For qualified C corporation farming and ranching operations, the maximum write-off for qualified conservation contributions was increased from the normal 10 percent of adjusted taxable income to 100 percent of adjusted taxable income in 2013. Qualified conservation contributions in excess of what could be written off in 2013 could be carried forward for 15 years.

    Favorable Rule for S Corporation Donations of Appreciated Assets- For tax years beginning in 2013, a favorable shareholder basis rule applied for stock in S corporations that made charitable donations of appreciated assets. For such donations, each shareholder’s tax basis in the S corporation’s stock was only reduced by the shareholder’s pro-rata percentage of the company’s tax basis in the donated assets.

    Without this provision, a shareholder’s basis reduction would have equaled the passed-through write-off for the donation (a larger amount than the shareholder’s pro-rata percentage of the company’s tax basis in the donated asset). This provision was taxpayer-friendly because it left shareholders with higher tax basis in their S corporation shares, which is almost always beneficial to shareholders.

    Mar 10

    Corporate Tax Deadline Fast Approaching

    By KLR Tax Services Team

    Even if you are well prepared this year, sometimes it’s easy to overlook deadlines while dealing with day-to-day business. The next major deadline coming up is for corporate tax returns on March 17th.

    March 17, 2014

    The deadline for the 2013 calendar year corporate tax returns, which include Forms 1120 and 1120S, is March 17th. The original deadline for corporate returns is March 15th, but this falls on a Saturday, so this year the deadline is being pushed back to the next business day, Monday, March 17th. 

    An Automatic Extension (Form 7004) can be filed, and is also due by March 17th.  This gives businesses an additional six months to file the return; payment is still due on March 17th. We recommend that you submit payment when applying for the extension.

    Mar 6

    Scorecard of the Key Expired Tax Breaks for Individuals

    By Norman LeBlanc

    There are several federal income tax breaks for individuals and businesses that expired at the end of 2013. Although we are well into 2014, Congress has—so far—failed to extend many of tax savings opportunities that you’ve become accustomed to. (Some observers predict that Congress won’t act for months — perhaps even until after the November mid-term elections.)

    Below is a summary of some noteworthy deductions for individuals and credits that won’t be available — or will be significantly reduced — in 2014. Many of these federal income tax breaks were available (at varying levels) for several years before expiring on 12/31/2013.

    Expired Tax Breaks for Individuals

    Option to Deduct State and Local Sales Taxes- In 2013, individuals had the option of claiming an itemized deduction for general state and local sales taxes instead of claiming an itemized deduction for state and local income taxes. This option was beneficial for taxpayers who live in states with no personal income taxes and taxpayers who pay only minimal state income taxes.

    Tax-Free Treatment for Forgiven Principal Residence Mortgage Debt- For federal income tax purposes, cancelled debts generally count as taxable cancellation of debt (COD) income. However a temporary exception applied to COD income from cancelled mortgage debt that was used to acquire a principal residence. Under the temporary provision, up to $2 million of COD income from principal residence acquisition debt that was cancelled between 2007 and 2013 was treated as a tax-free item for federal income tax purposes.

    Charitable Donations from IRAs- Individual retirement account (IRA) owners who had reached age 70 1/2 by December 31, 2013, were allowed to make charitable donations of up to $100,000 directly out of their IRAs in 2013. The donations counted as IRA required minimum distributions.

    So, charitably-inclined seniors who had more IRA funds than needed could reduce taxes by arranging for IRA donations to take the place of taxable required minimum distributions in 2013.

    Deduction for Higher Education Tuition and Related Fees- In 2013, you could deduct up to $4,000 (or up to $2,000 for higher-income folks) for qualifying higher education tuition and related fees paid for you, your spouse or your dependents.

    $500 Energy-Efficient Home Improvement Credit- For 2013, taxpayers could claim a tax credit of up to $500 for certain energy-saving improvements to a principal residence.
    Salary Reduction for Transit Passes- Your employer may allow you to sign up to reduce your taxable salary to pay for mass transit passes to commute to and from work. In 2013, the maximum monthly amount you could set aside on a tax-free basis was $245. The maximum monthly amount for 2014 will be only $130 unless Congress decides to allow a larger amount. (If that happens, the larger amount would be $250.)

    $250 Deduction for Teachers’ School Expenses- For 2013, teachers and other personnel at K-12 schools could deduct up to $250 of school-related expenses they paid out of their own pockets, regardless of whether they itemized or not.

    Deduction for Home Mortgage Insurance Premiums- In 2013, eligible taxpayers were allowed to treat qualifying personal residence mortgage insurance premium amounts as deductible home mortgage interest.

    Charitable Qualified Conservation Contributions- Charitable qualified conservation contributions are donations of real property interests (including remainder interests and easements) that restrict the use of real property. For individuals, the maximum write-off for 2013 qualified conservation contributions of long-term capital gain property was increased from the normal 30 to 50 percent of adjusted gross income.

    In addition, qualified conservation contributions were not counted when calculating an individual’s allowable 2013 write-offs for other charitable contributions. Qualified conservation contributions in excess of what could be written off in 2013 could be carried forward for 15 years (only a five-year carryover period is allowed under the normal rules). For an individual who was a qualified farmer or rancher, the qualified conservation contribution write-off for 2013 donations of farm or ranch real property could be as much as 100 percent of the donor’s adjusted gross income.

    Zero Percent Tax Rate on Future Gains from Qualified Small Business Stock- For qualified small business corporation (QSBC) stock that was issued in calendar year 2013, a 100 percent federal gain exclusion break is potentially available. That equates to a 0 percent federal income tax rate on future profits from selling QSBC shares down the road. You must hold the shares for more than five years to be eligible, and many companies will fail to meet the definition of a QSBC. Also, C corporation shareholders are ineligible. For QSBC shares issued in 2014, the “normal” gain exclusion percentage of 50 percent will apply unless Congress restores the 100 percent gain exclusion deal.

    Personal Credit for Alternative Fuel Vehicle Refueling Property- In 2013, individuals could claim a federal tax credit for up to 30 percent of the cost of installing non-hydrogen alternative fuel vehicle refueling property. This credit could be claimed for expenditures such as equipment to recharge electric-powered car batteries at a principal residence. For individuals, the annual cap for this credit was only $1,000. A credit for hydrogen refueling property is allowed through 2014.

    Stay tuned for our next blog on the Key Expired Tax Breaks For Businesses.

    Feb 27

    Tax Question of the Week: Have Home Office Deduction Rules Changed for 2013?

    By Norman LeBlanc

    As people are preparing their 2013 tax returns many are wondering if there are any changes to home office deductions. Yes, there are and the new option makes it simpler for qualifying taxpayers to include home office deductions on their 2013 tax returns.

    The IRS announced a simplified option that many owners of home-based businesses and some home-based workers may want to use to figure their deductions for the business use of their homes. The new option will “reduce the paperwork and record keeping burden on small businesses by an estimated 1.6 million hours annually,” according to the IRS.

    Beginning Jan. 1, 2013 taxpayers can use this option on their tax returns filed in 2014. It’s an alternative to the current calculation, allocation and substantiation requirements. However, because the new option has limits, a taxpayer may get a larger deduction by continuing to use the current rules. The optional deduction is capped at $1,500 each year based on $5 per square foot for up to 300 square feet.

    The current rules that are effective for 2012 returns require taxpayers to fill out the 43-line IRS Form 8829. It may contain complex calculations of allocated expenses, depreciation and carryovers of unused deductions.

    The new rules effective for the 2013 tax year and going forward require taxpayers claiming the optional deduction to complete a different, simplified form. They can’t depreciate the portion of their homes used in a trade or business, but they can claim allowable mortgage interest, real estate taxes and casualty losses on the home as itemized deductions. Unlike the current deductions that need to be allocated between personal and business use, these deductions do not need to be.

    Be aware that the new option doesn’t change the current restrictions on home office write-offs, such as requirements that a home office be used “regularly and exclusively” for business and that the deduction be limited to the income derived from a particular business.

    A taxpayer has the option to select which methods they would like to use when calculate actual home office expenses from year to year. An election for any taxable year, once made, is irrevocable. “A change from using the new method in one year to actual expenses in a succeeding taxable year, or vice-versa, is not a change in method of accounting” and doesn’t require IRS consent, according to the IRS.

    For more information about the simpler rules for deducting the cost of a qualifying home office please contact any member of our Tax Services Team at trustedadvisors@kahnlitwin.com or call 401-274-2001.

    Feb 24

    Considerations When Setting up an Employment Contract in China

    By Paul Oliveira, CPA

    Written in conjunction with KLR China affiliate Sabrina Zhang, National Tax Partner, Dezan Shira & Associates

    Establishing labor contracts in China is an essential, albeit complicated, process, and manufacturers setting up shop in the country should avoid moving forward before they fully understand the Chinese labor laws that dictate contract terms, salary stipulations and statutory vacation rules.

    Chinese labor laws are typically more stringent and rigid than those followed by U.S. employers, and the below considerations and guidelines may serve as a starting point when manufacturers begin formulating their workforce needs.

    1. Mandatory labor contracts
    China’s Labor Contract Law requires that companies operating in the country provide workers with an employment contract. These contracts are generally comprehensive and formal, and outline whether workers will be hired on a fixed-term, open-term or variable-term basis. By law, there are several employment stipulations that must be included in the contract, and are as follows:

    • Name, domicile and legal representative or main person in-charge of the employer
    • Name, residential address and number of the resident ID card or other valid identity document number of the worker
    • Term of the labor contract
    • Scope of work and place of work
    • Working hours, rest and leave
    • Labor compensation
    • Social insurance
    • Labor protection, working conditions and protection against occupational hazards
    • Other issues required by laws and regulations to be included in the labor contract

    According to the Labor Contract Law, an employer must ensure that it has completed a written labor contract with every staff member within one month of the employee commencing work.This is important because if such a contract is not in place by the end of the first month the employee will have the right to claim double salary for the period in which the company remains out of compliance with this regulation.

    If the company neglects to complete such a contract after the employee has worked for one whole year, not only can the employee claim double salary for the previous eleven months, they can also claim an open-term contract from the employer. This will mean that the employer loses the ability to terminate the contract of the employee at the end of the fixed-term contract.

    2. Salary
    A regional trend that often occurs in China is the expectation that salaries are paid on a 13-month basis, with the final month paid just prior to the Chinese New Year. Although this is not compulsory, it is common and expected in many areas of China, making it critical that U.S. employers outline whether they will adhere to this custom and put it in writing.
    The mandatory social insurance system in China also adds 35-40 percent to the cost for the employer on top of an employee’s salary.

    3. Statutory vacation rules
    China imposes strict vacation rules among its workforce, with which U.S. companies must comply. These rules dictate that employees do not receive a vacation during the first year of employment. They are then required five days of vacation in years two to 9, and 10 days of vacation in years 10 to 19. For those employed 20 years or more, 15 vacation days are allotted.

    4. Non-mandatory terms
    Although many of the laws in China are inflexible, employees have some negotiating room in their contracts. It’s not uncommon for employees to negotiate terms such as probation periods, on-the-job training, confidentiality/non-disclosure conditions and breach of contract stipulations. Therefore, companies hiring Chinese employees should determine beforehand how flexible they will be in agreeing to certain terms, if only to make for a more consistent hiring process.

    We also recommend that some reference be made to the company rulebook in the employment contract. This makes a clear association between the signing of the employment contract by the employee and their observation of the company rules.

    5. Contract termination laws
    China has very particular laws governing the termination of employment contracts, so U.S. company owners should be well-versed on what may constitute fair and unfair termination. There are also a number of scenarios in which owners are still bound by salary requirements, even in the event of a termination.

    In the case of an employment dispute, the burden of proof will fall primarily on the company, so it is critical that the employer organizes all documentation relating to its employment relationships in a thorough and consistent manner.In the case of termination, to show that an employee is not properly fulfilling their job duties or has violated company rules, employment documentation from throughout the employment relationship may prove useful, including:

    • Offer letter/letters of intent
    • Labor contract
    • Confidentiality agreement
    • Non-competition agreement
    • Employee handbook
    • Job description
    • Appraisal forms
    • Employee registration form

    6. Acknowledgment of contracts
    Labor arbitration is a common issue in China, making it critical that companies operating in the country ensure they have a formal and signed document from employees acknowledging receipt of their contract. Failure to provide this document during an arbitration process could result in significant financial losses to companies.

    PRE-PREGISTER NOW for our Doing Business in China: U.S. and China Perspective seminar series.

    Download our latest Resource Center Article: Q&A Interview with KLR and Dezan Shira on the advantages and disadvantages of doing business in China.

    Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam as well as liaison offices in Italy and the United States.

    Feb 19

    Tax Question of the Week: When I Sell an Investment, How Does My “Basis” Affect My Tax Bill?

    By Loree Dubois

    If you’re selling shares of stock, mutual funds or other investments, familiarize yourself with the cost basis rules before you call your broker. It is also important to be sure you understand the different accounting methods available for determining which shares you sell. The method you choose can have a big impact on your tax bill.

    Calculating basis

    When you sell an investment, the gain (or loss) is equal to the sale price less your adjusted cost basis. Your adjusted basis is the amount you paid for the investment, including commissions, adjusted to reflect certain events, such as corporate actions (for example, stock splits or mergers).

    Using this method requires detailed record-keeping. It is common for investors to fail to include automatic re-investments of mutual fund distributions in their basis calculations, which can be a costly mistake. Be sure to retain brokerage account and mutual fund statements and confirmations. If you’re unable to adequately document your basis, the IRS will assume that it’s zero.

    New reporting rules

    IRS regulations that are currently being phased in (see below) require financial providers such as brokers and mutual fund companies to track basis, holding period and sales proceeds for “covered securities” and to report this information to the investor and the IRS on Form 1099-B.

    Type of Security WEffective for shares acquired on or after
    Stocks and certain ETFs* Jan 1, 2011
    Mutual Funds, all ETFs and DRIPs** Jan 1, 2012
    Bonds, options and all other securities Jan 1, 2014

    * Exchange traded funds
    ** Dividend reinvestment plan

    Although these rules relieve some of the pressure on investors to calculate basis, they aren’t a sure fire method for a few reasons. First, the regs apply only to securities acquired after the relevant effective dates, so you remain responsible for reporting basis for older securities. Second, even if a financial provider tracks your basis, you may want to choose the accounting method to help ensure you obtain the tax treatment that will best achieve your goals.

    Accounting methods

    If you own multiple lots of a security acquired at different times for different prices and you sell a portion of your holdings, your choice of accounting method has significant tax implications. Below are the top three most popular methods:

    1. First-in, first-out (FIFO). The IRS default method, FIFO assumes that the first shares purchased are the first shares sold. It has the advantage of simplicity. But if share values rise over time, FIFO increases your tax bill because older shares have a lower basis.
    2. Specific Identification. Under this method, you specify which shares are sold. It complicates record-keeping, but it gives you the flexibility to minimize your taxes. Suppose you purchased shares of a particular security as follows:

      • Five years ago, you purchased 1,000 shares at $50 ($50,000)
      • Three years ago, you purchased 1,000 shares at $75 ($75,000)
      • One year ago, you purchased 1,000 shares at $100 each ($100,000)

      Now, say you plan to sell 1,000 shares at $110 ($110,000). FIFO assumes that you’re selling the block of shares you purchased five years ago, for a capital gain of $60,000 ($110,000 - $50,000). Using specific identification, on the other hand, you can sell the block you purchased one year ago, for a capital gain of only $10,000 ($110,000 - $100,000).

      For your convenience, a financial provider may offer various standing orders to choose from, such as last-in, first-out (LIFO) or highest-cost, first-out. Still, you should review each potential sale to avoid unwanted tax consequences. You may prefer to generate higher gains to offset capital losses during the year, for example.

      Also, while selling the highest-cost shares tends to minimize gains, if you acquired the shares within the last year, those gains will be short-term gains taxed at your higher ordinary-income rate. To determine the optimal strategy, you must weigh the impact of smaller gains taxed at a higher rate against larger gains taxed at a lower rate.

      Some providers offer a plan under which they select shares that minimize your tax liability, taking into account cost bases and holding periods.

    3. Average cost. For mutual funds only, you can use average cost as the basis of all shares. In the above example, the average cost is $75. Presuming you purchased mutual funds and used the average-cost method, the sale would generate a capital gain of $35,000 ($110,000 - $75,000).

      This method generates less tax than FIFO but more than the specific-identification method. It also offers simplicity and tends to distribute your tax liability evenly over time.

      It is important to note that once you’ve sold shares using the average-cost method, you can change your method only for later-acquired shares. The basis of existing shares is locked in.

    Whichever method you choose, it’s important to communicate it to your financial provider before you sell.  For many, the default is average cost calculation for mutual funds and FIFO for everything else. For more information on how the sale of investments affects your tax bill please contact any member of our Tax Services Team at trustedadvisors@kahnlitwin.com or call 401-274-2001.

     

     

    Feb 11

    Tax Question of the Week: Do I Need Professional Appraisals of my Non-cash Gifts?

    By Norman LeBlanc

    To lower your chances of an unplanned tax liability when making a substantial noncash gift a professional appraisal can reduce the likelihood of the IRS challenging your gift tax return.

    3-year statute of limitations

    If you make a substantial noncash gift — either outright or in trust — IRS regulations provide for a three-year statute of limitations during which the IRS can challenge the value you report on your gift tax return. After the three-year period expires, you can enjoy the peace of mind that comes with knowing that your estate plan will work as you intended.

    However, there is a catch: The statute of limitations doesn’t begin until your gift is “adequately disclosed” on a gift tax return. According to the IRS, to adequately disclose a gift, you must provide:

    • A detailed description of the nature of the gift
    • The relationship of the parties to the transaction
    • The basis for the appraisal
    • You may also be required to furnish certain financial statements or other financial data and documents

    You can satisfy the adequate disclosure rule’s information requirements by submitting an appraisal report by a qualified, independent appraiser that includes details about the property, the transaction and the appraisal process. In most cases, this is the most effective way to ensure that you’ve disclosed gifts adequately and triggered the statute of limitations. Even if a gift’s value falls under the $14,000 annual exclusion and thus won’t be taxable, it is generally a good idea to file a gift tax return to trigger the statute of limitations.

    Misstatement penalties can add up

    If for some reason an insufficient appraisal is conducted it puts you at risk for penalties and additional taxes from the IRS if they find out that the property was substantially or grossly misstated.
    A “substantial” misstatement occurs when you report a value that is 65% or less of the “correct” value. A “gross” misstatement occurs when you report a value that is 40% or less of the correct value. The penalty for a substantial misstatement is 20% of the amount by which your taxes are underpaid. Gross misstatements result in a 40% penalty.

    Appraise your assets

    Reduce your chances of triggering an IRS review of your gift tax return by having a member of the Tax Services Team value your substantial noncash gifts at the time of the transaction. Email trustedadvisors@kahnlitwin.com or call 401-274-2001 for help with a variety of other estate planning strategies that require having accurate, supportable and well-documented appraisals of assets.

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