September 2007
Tax Pointers for Investors
September 2007
Tax Pointers for Investors
Taxes are probably not foremost in your mind when you're making investment-related decisions. And that's the way it should be. Still, you don't want the investment transactions you make in your taxable accounts to catch you by surprise at tax time. Here are some points to keep in mind.
Capital gains rates. Profits earned on the sale of stock or mutual fund shares are taxed as capital gains. But not all capital gains are treated equally for tax purposes. Gains earned on securities held more than one year before sale ("long-term") are generally taxed at 15%. On the other hand, if you sell your securities before you've met the long-term holding period, your gain could be taxed at ordinary rates as high as 35%.
Late-year mutual fund purchases. Each year, mutual funds capital gains earned on fund investment transactions to their shareholders, typically during the last quarter of the year. Before distribution, gains are accounted for in the fund's share price. So buying shares just before a fund goes ex-dividend in essence means you'll pay the fund for the distribution you are about to receive - and then have to turn around and report the "gain" on your tax return. You could avoid the extra income by waiting until after the ex-dividend date to make your purchase.
Dividend rates. Dividend income can qualify for the same preferential tax rates as long-term capital gains. But you must hold the underlying stock for a specified holding period (generally for more than 60 days during the 121 day period beginning 60 days before the stock's ex-dividend date). Certain dividend distributions form mutual funds can also qualify for the low rates.
Accrued interest.
when you buy a bond between interest payment dates, the portion of the unpaid interest that accrued while the seller owned the bond is added to the purchase price. That amount is taxable to the seller, not to you.
Municipal bond interest. Usually, this interest is exempt from federal income taxes. But not always. While not includable in your regular income, interest earned on certain "private activity" municipal bonds has to be included in your income when figuring your potential liability for alternative minimum tax (AMT).
Businesses can't simply write off their asset purchases like any other business expense. The costs of fixed assets generally have to be recovered over several years by way of depreciation deductions. There is an exception, however. Section 179 of the tax code provides an an immediate deduction for a limited amount of asset purchases each year.
Higher maximum. The Small Business and Work Opportunity Tax Act of 2007 has raised the limit on the amount that may be expensed under Section 179. For the 2007 tax year, the limit has been set at $125,000, up from $112,000 under prior law.
Phaseout. If total qualifying purchases exceed $500,000, the $125,000 deduction limit is reduced. Once purchases reach $625,000, no Section 179 election may be made. Note that the Section 179 election isn't available for real estate, and real estate need not be counted for purposes of the phaseout.
As under prior law, the Section 179 expense deduction is limited to trade or business income for the year.
Employers looking to sponsor a tax-advantaged retirement plan have several choices. The profit-sharing plan is one popular choice, especially when used in combination with a 401(k) salary deferral plan.
On the Plus Side A profit-sharing plan is very flexible. The employer isn't locked into making a certain size contribution to the plan each year. Instead, the employer decides how much to contribute (within tax law limits). If need be, the employer can skip making a contribution.
A Downside Like other tax-qualified plans, a profit-sharing plan can't discriminate in favor of highly compensated employees. To meet this requirement, a standard profit-sharing plan generally allocates the employer's plan contribution among eligible employees based on a uniform percentage of compensation. Here's an example of how it might work:
| Salary | 10% Profit-sharing Allocation | |
| Employee 1 (Owner) | $200,000 | $20,000 |
| Employee 2 | $50,000 | $5,000 |
| Employee 3 | $35,000 | $3,500 |
| Total | $285,000 | $28,500 |
This approach is straightforward, but it does have a potential drawback. The contributions the business can afford to make might not be large enough to provide an adequate retirement benefit to owners and other key employees.
A Potential Solution In that case, a "new comparability" plan design can be a solution. With this design, the profit-sharing plan is tested for nondiscrimination based on the projected future value of the benefits the plan will provide at normal retirement age. In many cases, highly paid employees can receive greater allocations of the profit-sharing contribution (as a percentage of their compensation) than employees who don't earn as much.
Keeping expenses at manageable levels is always a challenge for small businesses and professional practices, even for firms that are very profitable. A profit-sharing plan - with a new comparability design - can be an option worth exploring.
Until they enter the work force full-time, most children who have any taxable income have only limited amounts. Limited income translates to a low tax bracket. So, without rules to prevent it, parents interested in cutting the income taxes payable on their own investment income could simply put some of their investments in their kids' names.
Congress didn't want that to happen so, years ago, it put "kiddie tax" rules in place that curtail opportunities for parent-to-child income shifting. The law became stricter last year, and now the unearned income of a child under age 18 is taxed at the parents' rate to the extent it exceeds $1,700.
Starting in 2008, the Small Business and Work Opportunity Tax Act of 2007 extends the kiddie tax to older children who receive the majority of their support from sources other than their own earnings. Under the new law, the tax will also apply to 18 year olds and full-time students ages 19 through 23 whose earned income does not exceed half of their total annual support. Scholarship money won't be counted in figuring the total amount paid for a child's support.
It view of the upcoming change, families may want to review their portfolios. Dependent students who will be turning ages 19 through 23 next year might consider selling appreciated securities in 2007 so that the resulting gains will be taxed at their own rates. Of course, investment sales should also make sense from a non-tax viewpoint.
In the real estate world, leverage - the use of borrowed funds to partially finance your investment - can work for you or against you.
Example. Let's say you buy real estate for $400,000. You put $80,000 cash down (20%) and borrow $320,000, the rest of the purchase price. For simplicity, assume no payments are required on the loan for one year and income and taxes aren't taken into consideration.
For you. In a year's time, the property appreciates by 5%, and you sell it for $420,000. After paying back the $320,000 loan, you pocket $100,000. You're ahead by $20,000, or 25%.
Against you. Instead of going up, assume the value of the property declines by 10% over the course of the year. You need to sell it quickly, so you accept a buyer's offer of $360,000. After paying back the loan, you're left with $40,000. Even though the property's value dropped by only 10%, you've lost half of your original $80,000 investment.
When regularly prepared, financial statements are a useful internal management tool that can help owners and managers keep tabs on company operations and plan for growth. Statements, also are used to tell a company's financial story to "outsiders" - banks, insurers, leasing companies, major suppliers and customers, potential investors, and others who need reliable information about the business in order to assess its financial strength and earnings capacity.
Basic Statements. A balance sheet is a snapshot of a company's financial position - its assets, liabilities and equity - as of a particular date, such as the last day of the year. An income statement summarizes revenues and expenses for a period of time, often one year. A statement of cash flows gives information about the sources and uses of case over the reporting period. Changes in equity over the period are often outlined in a statement of stockholder's equity and sometimes in a separate statement of comprehensive income.
Additional Information. Usually, statements prepared for external use are accompanied by a section of notes. The notes give more detail about significant transactions and account balances. Additional detail about expenses and other items may be provided in supplementary schedules.
CPA Services
CPAs provide three levels of professional service with respect to financial statements:
Checking with potential financial statement users about their requirements can help companies determine which level of service will best meet their needs.
Reminder: The federal minimum wage increased from $5.15 per hour to $5.85 per hour, effective July 24, 2007. This is the first of three .70¢ hikes. Effective July 24, 2008, the federal minimum wage will be $6.55 per hour, and it will increase again to $7.25 per hour on July 24, 2009. Where the applicable state minimum wage is higher, employees are entitled to the higher rate.
Only 4.7% of American commuters used public transportation to get to work in 2005, and about half of them were located in just 10 cities. So how did most Americans get to work? According to the U.S. Census Bureau, 87.7% drove, and 77% drove alone.
Between the ages of 35 and 65, men working in white-collar jobs stand a 27% chance of becoming disabled for 90 days or longer, and women stand a 31% chance, according to a Milliman, Inc. study released earlier this year.
Home-care workers employed by agencies are not entitled to overtime pay under federal law, holds the U.S. Supreme Court in a recent decision.
Cheryl's landscaping business is really taking off. So far, she's taken care of all the finances. But finding the time to do it all herself has become difficult, and Cheryl is thinking of turning over the responsibilities to a trusted assistant.
It makes sense for Cheryl to delegate some of her responsibilities so she can focus on other aspects of the business. That said, she should be careful to build in some checks and balances, especially where her company's finances are concerned.
Although she trusts her assistant, Cheryl should set up a system that ensures separation of duties. This means involving more than one person in the various financial tasks. For instance, she might have one person open the mail and another one prepare the bank deposits. This may not prevent all problems - but it will make it more difficult for any one person to mishandle the money.
Another safeguard: Have someone reconcile bank statements balances to the cash balances in the company's books. Any discrepancies should be investigated. They could be the result of errors - or signs of a problem, such as fraud. Since reviewing the statements will give Cheryl a good overview, she should continue to have them mailed directly to her. After she reviews the statements for unusual activity, the reconciliation can be prepared.
Implementing internal controls such as these is as important for small businesses as it is for large companies. Do you have an effective system of checks and balances in place? We'd be happy to take a look and give you our suggestions.
Question: Can I pay my federal business taxes by credit card?
Answer: Yes, you can pay balances due on certain returns (e.g., Form 940 and Form 941) by credit card over the Internet or by phone. And, if your card offers rewards, your tax payment may be an eligible charge (unless it's considered a cash advance). But it will cost you: Payment processing companies charge a fee (which many be deductible as a business expense). The big question is: Can you handle the extra debt in case you can't pay your credit card bill?
Question: If I pay to attend a charity's fundraising event, is the cost of the ticket deductible as a charitable donation?
Answer: Generally speaking, the amount that is considered a donation is the amount you paid to attend minus the fair market value of the meal, gift and/or anything else you receive while attending the event. For example, if you pay $120 for a ticket to a fundraising dinner and the meal is worth $75, your charitable donation is $45.