February, 2006
Think Twice About Spending Your Savings
February, 2006
Think Twice About Spending Your Savings
When today's typical 25-year-olds reach age 65, they will have worked, on average, for seven or more employers.* All that job changing will mean that workers who participate in their employers' retirement plans may face this important decision several times: Should they pocket their savings when they leave or keep the money growing tax deferred?
Several Options
When plan participants terminate employment (willingly or otherwise), they are typically entitled to a distribution of the vested portion of their retirement plan account. The employee can take the distribution in cash, request that the funds be transferred to another employer's plan or an individual retirement account (IRA), or leave the money where it is (if the current employer's plan permits).
Take It? They'll Tax It
The government encourages people to keep their retirement savings in tax-deferred accounts when they change jobs. Recent changes in the tax law make it easier for workers to move their retirement savings from one type of plan to another.
Conversely, early distributions are discouraged: The tax law imposes a 10% penalty on distributions taken before age 59-1/2. (Some exceptions apply.) The penalty is payable in addition to income tax, further reducing the amount available to the employee.
Example: Jane is 36 years old and is changing job. She's planning to take the $15,000 in her retirement account to pay off some large bills. Here's what she'll have after paying the IRS:Jane's vested plan balance - $15,000
Income tax (marginal rate=15% - -2,250
10% penalty tax - -1,500
Jane's net payout - $11,250
Rollover Rewards
If Jane rolls over her $15,000 balance instead, and earns an average annual total return of 7%, this is what she might find:
Jane's rollover amount: $15,000
5 years - $21,038
10 years - $29,507
20 years - 58,045
30 years - $114,184
If you're eligible for a distribution from your retirement plan, think twice before you spend it.
*Congressional Research Service Report, "Pension Issues: Lump-sum Distributions and Retirement Income Security," 8/5/05.
The IRS has made some changes to the rules for obtaining tax filing extensions.
Individuals can now receive an automatic six-month extension of time to file their 2005 federal income-tax returns by filing Form 4868. In the past, the automatic extension period was only four months, and individuals needs more time had to request an additional two month extension.
An automatic six-month extension remains available to corporate taxpayers that need more time to file their income-tax returns, but Form 7004, the form used to request the extension, has been modified.
Partnerships, certain trusts, and real estate mortgage investment conduits (REMICs) may also request an automatic six-month filing extension using the new Form 7004.
Employee benefit plans should use the new Form 5558 to request an automatic two-and-one-half month extension of time to file Form 5500.
When your workplace is as close as your basement or spare room, the boundary between home and business probably gets blurry at times. If for no other reason than your taxes, however, it's important to separate the two.
What's Deductible?
As the owner of a home-based business or professional practice, you may be able to deduct various expenses related to using your home for business purposes. Some examples:
Since many expenses relate to the entire home, the calculation of the business portion is usually accomplished using square footage.
Example: The square footage of Meredith's home office is 10% of her home's total square footage. Last year, Meredith paid $1,200 to heat her home. She may deduct $120 (10%) as a business expense, provided she meets the tax law's requirements for a home office deduction.
Off Limits - Deductions for an "office" in the home are generally available only if the space is used regularly and exclusively for business. The exclusive-use rule can be particularly difficult to follows:
Example: During business hours, Derek's home office is used strictly for business. But Derek also uses it as a bedroom when his kids visit. Derek's office doesn't qualify as a home office, even though there is no personal use of the room during the workday.
Ordinarily, you may exclude up to $250,000 of capital gain ($500,000 if married) from your income when you sell your home, provided you have owned and used it as your principal residence for at least two of the five years before the sale. When you have a home office, however, you have to pay tax (at a 25% rate) on capital gain up to the amount of prior depreciation on the home. Any additional gain can qualify for the $250,000/$500,000 exclusion.
Example: The Garcias made a $100,000 profit when they sold their principal residence. Although they meet the tax law's requirements for a capital gain exclusion of up to $500,000, they will have to pay tax on 415,000 of their profit - the amount they previously deducted as home office depreciation.
When you hire new employees, you're required to verify their identity and their eligibility to work in the U.S. Regardless of nationality, new employees must complete Form I-9, the "Employment Eligibility Verification" form from the Department of Homeland Security.
I-9 forms are not filed with the government. But employers are required to keep I-9s on file for three years from the date an employee is hired or one year after employment is terminated, whichever is later. Here are some other compliance issues you should be aware of:
Consider keeping I-9 forms and copies of supporting documents together in a separate file so they'll be easily accessible should a government inspector want to see them. And be sure to review I-9s against your payroll records once a year.
Looking for motivated employees? Consider hiring college interns. Many college and university programs require under-graduates and graduates to round out their academic studies with practical field experience. Hiring interns can be advantageous for your business in many ways.
Okay, so saving a few pennies probably won't change your profit picture significantly. But the philosophy - not spending more than you have to - is still a smart way to do business. Add your own creative solutions to these penny-pinching guidelines.
Find a Group
Find out if there's a business group or trade association that offers discounts to members. Joining may give you access to health and other types of insurance at a discount. Trade groups often negotiate discounts on long-distance and cell p hone services, shipping rates, car rentals, airplane tickets, and other travel benefits for their members as well.
Think about forming a "purchasing partnership" with other small businesses in your area to get lower bulk quantity prices on such things as office supplies. Depending on the type of business you're in, you may be able to share office space, equipment, and even personnel to keep costs down.
Rally the Troops
Get employees to adopt your cost-saving ideology. After all, a better bottom line could mean better benefits. Encourage people to keep their eyes open. for example, check invoices carefully to make sure you get the pricing you've been promised. Check your own billing for accuracy. too.
Turn banks and suppliers in to partners by asking them to suggest ways to keep costs down. If a new vendor offers you a good deal, try negotiating with your current one for a better price.
Take the Credit (or Deduction)
Recent tax law changes have introduced several tax-saving opportunities for businesses. For example, the Section 179 expensing deduction is about four times higher than it was in 2002. Also, there are temporary tax credits for the purchase of certain fuel-efficient cars and for upgrading the energy efficiency of commercial buildings. Some of these tax breaks are set to expire in the near future.
Keeping track of tax-saving opportunities and cost-cutting financial strategies for businesses like yours is our full-time job. Feel free to contact us anytime.
Last year, the IRS audited about 1-in-63 individuals and families reporting $100,000 or more in earnings. The audit rate for small businesses with assets of less than $10 million was 1-in-126.
Production workers who are required to wear protective gear while working in a plant must be paid for the time they spend walking to and from changing areas to the production floor, ruled the U.S. Supreme Court in a recent decision. Employees also must be paid for the time they spend waiting to change out of the gear.
The IRS has issued lengthy regulations (in proposed format) outlining details regarding the new deduction for a percentage of business income earned from manufacturing and certain other production activities occurring in the U.S. The deduction percentage is 3% for tax years beginning in 2005 and 2006.
Raul will owe the IRS a substantial amount when he files his 2005 tax return. How can he trim his 2006 tax liability?
The best way for Raul to avoid another hefty tax bill next year is to become proactive in his tax planning. While many strategies are available, most are effective only if steps area taken before a transaction occurs.
Because Raul owns a large investment portfolio, he may wish to focus his tax planning on it. While Raul shouldn't allow taxes to drive his decisions, he would be unwise to disregard the tax implications of his investment transactions.
Raul owns shares in a number of mutual funds. If he decides to sell only a portion of his holdings in a particular mutual fund, he should decide in advance which method of determining his cost basis in the shares sold with be most advantageous to him from a tax perspective. Then, if need be, he can tell his broker or fund representatives which particular shares to sell. The key is to carefully choose a method before selling.
Raul's high tax bracket may make municipal bonds an attractive choice for the fixed income portion of his portfolio. Interest on municipal bonds is generally exempt from federal income taxes and also may be exempt from state income taxes in the state of issuance.
If you have a tax planning question or concern, we urge you to talk with us. We'd be pleased to assist you.
Q. Last year, our nonprofit organization used the services of an independent contractor who specializes in historic building renovations. We paid him $65,000. Do we have to report this information in our annual Form 990 filing?
A. You may have to. A draft of Schedule A for 2005 (which is attached to Form 990) asks for the names, addresses, services provided, and compensation of the five highest paid contractors paid over $50,000 for services other than professional services. At present time, the final version of the form had not been released.
Q. Our company just had a lot of landscaping done around the new office building that's being constructed for us. Will the cost be depreciable?
A. The landscaping that would be destroyed should your office building be replaced (e.g., tress and shrubs) is considered to ave a "life" associated with the "life" of the building. So, you'll be able to depreciate the cost of landscaping adjacent to your building. Landscaping around the perimeter of the lot, however, is considered general land improvement. The cost of the perimeter plantings increases your basis in the land, but is not depreciable.