Interfamily gifts
Because of the tax planning opportunities family partnerships present, they are closely scrutinized by the IRS. When a family member acquires a partnership interest by gift, however, the validity of the partnership may be questioned. For example, a partnership between a parent in a personal services business and a child who contributes little or no services is likely to be disregarded as an attempt to assign the parent’s income to the child. Similarly, a purported gift of a partnership interest may be ignored if, in substance, the donor continues to own the interest through his power to control or influence the donee’s business decision. When a partnership interest is transferred to a guardian or trustee for the benefit of a family member, the beneficiary is considered a partner only if the trustee or guardian must act independently and solely in the beneficiary’s best interest.

Capital or services
The determination of whether a person is recognized as a partner depends on whether capital is a material income-producing factor in the partnership. Any person, including a family member, who purchases or is given real ownership of a capital interest in a partnership in which capital is a material income-producing factor is recognized as a partner automatically. If capital is not a material income-producing factor (for example, if a partnership derives most income from services, a family member is not recognized as a partner unless all the facts and circumstances show a good faith business purpose for forming the partnership.

If the family partnership is recognized for tax purposes, the partnership agreement generally governs the partners’ allocations of income and loss. These allocations are not respected, however, to the extent the partnership agreement does not provide reasonable compensation to the donor for services he renders to the partnership or allocates a disproportionate amount of income to the donee. The IRS can re-allocate partnership income between the donor and donee if these requirements are not met.

Investment partnerships
The general rule for determining gain recognition for marketable securities does not apply to the distribution of marketable securities by an investment partnership to an eligible partner. An investment partnership is a partnership that has never been engaged in a trade or business (other than as a trader or dealer in the certain specified investment-type assets) and substantially all the assets of which have always consisted of certain specified investment-type assets (which do not include, for example, interests in real estate or real estate limited partnerships).

If a family limited partnership (FLP) qualifies as an investment partnership, the FLP could redeem the partnership interest of an eligible partner with marketable securities without the recognition of any gain by the redeemed partner. To qualify, substantially all the assets of the FLP must always have consisted of the eligible investment assets, and the holding of even totally passive real estate interests (real estate that does not constitute a trade or business), for instance, must be kept to a minimum. In addition, any eligible partner must have contributed only the specified investment assets (or money) in exchange for his or her partnership interest.

This article reviews some of those deductions for which the IRS requires you to generate certain records either contemporaneously as the expense is being incurred, or at least no later than when you file your return. We also highlight several deductions for which contemporaneous documentation, although not strictly required, is extremely helpful in making your case before the IRS on an audit.

Charitable contributions. For cash contributions (including checks and other monetary gifts), the donor must retain a bank record or a written acknowledgment from the charitable organization. A cash contribution of $250 or more must be substantiated with a contemporaneous written acknowledgment from the donee. “Contemporaneous” for this purpose is defined as obtaining an acknowledgment before you file your return. So save those letters from the charity, especially for your larger donations.

Tip records. A taxpayer receiving tips must keep an accurate and contemporaneous record of the tip income. Employees receiving tips must also report the correct amount to their employers. The necessary record can be in the form of a diary, log or worksheet and should be made at or near the time the income is received.

Wagering losses. Gamblers need to substantiate their losses. The IRS usually accepts a regularly maintained diary or similar record (such as summary records and loss schedules) as adequate substantiation, provided it is supplemented by verifiable documentation. The diary should identify the gambling establishment and the date and type of wager, as well as amounts won and lost. Verifiable documentation can include wagering tickets, canceled checks, credit card records, and withdrawal slips from banks.

Vehicle mileage log. A taxpayer can deduct a standard mileage rate for business, charitable or medical use of a vehicle. If the car is also used for personal purposes, the taxpayer should keep a contemporaneous mileage log, especially for business use. If the taxpayer wants to deduct actual expenses for business use of a car also used for personal purposes, the taxpayer has to allocate costs between the business and personal use, based on miles driven for each.

Material participation in business activity. Taxpayers that materially participate in a business generally can deduct business losses against other income. Otherwise, they can only deduct losses against passive income. An individual’s participation in an activity may be established by any reasonable means. Contemporaneous time reports, logs, or similar documents are not required but can be particularly helpful to document material participation. To identify services performed and the hours spent on the services, records may be established using appointment books, calendars, or narrative summaries.

Hobby loss. Taxpayers who do not engage conduct an activity with a sufficient profit motive may be considered to engage in a hobby and will not be able to deduct losses from the activity against other income. Maintaining accurate books and records can itself be an indication of a profit motive. Moreover, the time and activities devoted to a particular business can be essential to demonstrate that the business has a profit motive. Contemporaneous records can be an important indicator.

Travel and entertainment. Expenses for travel and entertainment are subject to strict substantiation requirements. Taxpayers should maintain records of the amount spent, the time and place of the activity, its business purpose, and the business relationship of the person being entertained. Contemporaneous records are particularly helpful.

Contact our office for more information about tax deductions and documentation.

The government has found that most employees want at least a partial lump sum payment at retirement, so that some cash is currently available for living expenses. However, under current rules, most employer plans do not offer a partial lump sum coupled with a partial annuity. Employees often are faced with an “all or nothing” decision, where they would have to take their entire retirement benefit either as a lump sum payment when they retire, or as an annuity that does not make available any immediate lump-sum cash cushion. For retirees who live longer, it becomes difficult to stretch their lump sum benefits.

Longevity solution
To address this dilemma, the government is proposing new retirement plan rules to allow plans to make available a partial lump sum payment while allowing participants to take an annuity with the other portion of their benefits. Furthermore, to address the problem of employees outliving their benefits, the government would also encourage plans to offer “longevity” annuities. These annuities would not begin paying benefits until ages 80 or 85. They would provide you a larger annual payment for the same funds than would an annuity starting at age 70 1/2. Of course, one reason for the better buy-in price is that you or your heirs would receive nothing if you die before the age 80 or 85 starting date. But many experts believe that it is worth the cost to have the security of knowing that this will help prevent you from “outliving your money.”

To streamline the calculation of partial annuities, the government would allow employees receiving lump-sum payouts from their 401(k) plans to transfer assets into the employer’s existing defined benefit (DB) plan and to purchase an annuity through the DB plan. This would give employees access to the DB plans low-cost annuity purchase rates.

According to the government, the required minimum distribution (RMD) rules are a deterrent to longevity annuities. Because of the minimum distribution rules, plan benefits that could otherwise be deferred until ages 80 or 85 have to start being distributed to a retired employee at age 70 ½. These rules can affect distributions from 401(k) plans, 403(b) tax-sheltered annuities, individual retirement accounts under Code Sec. 408, and eligible governmental deferred compensation plans under Code Sec. 457.

Tentative limitations
The IRS proposes to modify the RMD rules to allow a portion of a participant’s retirement account to be set aside to fund the purchase of a deferred annuity. Participants would be able to exclude the value of this qualified longevity annuity contract (QLAC) from the account balance used to calculate RMDs. Under this approach, up to 25 percent of the account balance could be excluded. The amount is limited to 25 percent to deter the use of longevity annuities as an estate planning device to pass on assets to descendants.

Coming soon
Many of these changes are in proposed regulations and would not take effect until the government issues final regulations. The changes would apply to distributions with annuity starting dates in plan years beginning after final regulations are published, which could be before the end of 2012. Our office will continue to monitor the progress of this important development.

Gift Planning
An implemented gift program is one of the best ways to reduce the value of a person’s overall estate, thereby, reducing the person’s potential estate tax upon death.

Annual Gifting
Making annual gifts utilizing the $13,000 annual exclusion per donee is an effective way to reduce a person’s estate. Because the annual exclusion is applied on a per donee basis, a donor can leverage the exclusion by making gifts to multiple members of the same family including the spouse of a son or daughter. The donor’s spouse can also make gifts, therefore, doubling the gifts to $26,000 per donee. If the donor makes a gift of his or her separate property in the amount of $26,000, the donor and spouse can elect to split the gift on the annual gift tax return.

In addition to the annual gift tax exclusion, a person can make tuition payments for any individual without incurring any gift tax or use of his lifetime gift and estate tax exemption ($5,000,000 for 2011 and $5,120,000 for 2012). Though the amount that may be excluded as a gift is not limited, all payments must be made directly to a tax-exempt school of any grade level for the purpose of education. The exclusion applies only to tuition. Thus, payments for room and board, books, required equipment and related expenses are not an excludable gift.

Another payment that is not treated as a taxable gift is the payment of medical expenses. Again, the payments must be paid directly to the medical provider. These medical expenses can be made on behalf of any individual but must be of the type that qualifies for a medical deduction. The exclusion for medical payments would also include the payment of medical insurance premiums. The payment of medical expenses is an efficient means of making a tax-free gift that does not use either the annual exclusion or the lifetime gift tax exclusion. And if the person is a dependent, the donor can claim the medical expenses as an itemized deduction.

Larger Gifts for 2011 and 2012
The lifetime gift tax exclusion has substantially increased from $1,000,000 in 2010 to $5,000,000 in 2011 and $5,120,000 in 2012. The exclusion will revert back to $1,000,000 in 2013 unless Congress enacts legislation. Thus, there is a two year window for making substantial gifts. With the new portability rules for deceased spouses, a surviving spouse can utilize the unused lifetime exclusion of the deceased spouse, thus potentially obtaining$10,000,000 lifetime exclusion. This is only effective for spouses who have deceased in 2011 and 2012 and for which an election has been made on the deceased spouse’s timely filed estate tax return. The portability rule does not apply for generation- skipping transfers, thus the donor only has his $5,000,000 ($5,120,000 in 2012) lifetime exemption for making gifts to grandchildren or great-grandchildren.

Discounts
Discounts have been widely used in valuation of closely held businesses or partial interests in property. A family partnership organized as a limited partnership has been regularly used in the estate and gift tax planning context. A family limited partnership (FLP) is more preferable than a closely held corporation because of the flexibility of a partnership regarding the non-taxability of capital contributions and distributions and the availability to “step-up” the basis of the partnership’s assets on the death of a partner, which is not available to a corporation that is taxed as an S Corp or C Corp. The parents can maintain control of the partnership by being the general partners of the partnership and gifting only limited interests to the children and grandchildren.

Only business assets should be transferred to the partnership. The courts have only allowed small discounts for liquid assets in a FLP, such as publicly traded stock. If small minority gifts are made, for valuation purposes, a minority discount can be applied, and if the assets in the FLP are illiquid, a marketability discount can be applied. The discounts allowed generally range between 20%-50%, depending on the circumstances and the type of assets held. Discounts can also be applied to partial interests in property such as real estate.

The objective for estate tax purposes would be to assure that the transferred partnership interests are not includible in the estate of the transferor. The partnership agreement should specify that the general partner is bound by fiduciary duties in managing and operating the partnership. The transferor must not retain possession or control or the right of the income from the transferred assets. It would be preferable to make periodic distributions to all partners so that it is evident that the donees are receiving benefits from the transferred partnership interests. The IRS has had only partial success in disallowing valuation discounts for gift and estate purposes, usually if the FLP was created shortly before death.

Legislation was introduced in 2009 to disallow discounts in valuing the closely held interests. The 2010 Tax Reform Act did not contain any restrictions on discounts, so it is still a viable estate planning tool for 2011 and possibly 2012.

Grantor Retained Annuity Trusts

Short-term GRATS
A common estate planning technique is to use Grantor Retained Annuity Trusts (GRATs) to shift value out of the person’s estate. The use of two or three year GRATs are common. The objective is to transfer the asset to an irrevocable trust and to make the gift a nontaxable gift or a “zeroed out” GRAT. The donor will receive an annuity, annually, plus interest using the current IRS interest rate, which is relatively very low in 2011. Thus, for a two year GRAT, one-half of the asset contributed to the trust plus the amount of the computed interest would be distributed back to the grantor from the trust after year one. If the asset does not appreciate in value by the end of year two, the donor will have received the entire asset back from the trust.

However, if the asset has appreciated, the amount of the appreciation less the computed interest for the two years will be transferred to the beneficiaries of the trust at the end of year two. This is a technique used to transfer wealth without using any annual gift tax exclusion or lifetime exemption. Publicly traded stock is commonly transferred to this type of GRAT.

If the donor dies prior to the termination of the trust, the assets in the GRAT are included in the estate of the donor. This is why the short-term GRATs are so popular. There has been legislation introduced to eliminate short-term GRATs, requiring a GRAT to contain a term of at least ten years. There was no such legislation in the 2010 TRA, so the short-term GRAT should remain viable for 2011 and possibly 2012.

Long-term GRATS
Longer term GRATs can be a very effective estate planning tool to transfer wealth if the assets transferred are income producing and the income produced is much higher than the long term AFR rate. For example, if commercial real estate valued at $1,000,000 was transferred to a GRAT with annual cash flow of 7%, the trust terms could require a 7% annuity to be paid to the grantor. If the term of the trust was set at 15 years and the long term AFR rate was 1.6%, the value of the remainder interest, which is the taxable gift, would only be $53,833. The grantor has removed $941,167 plus any appreciation of the real estate from his taxable estate. At the end of the trust term, the remainder beneficiaries will receive title to the commercial real estate. It is important to make the term of the trust less than the life expectancy of the income beneficiary, so that the likely hood of the grantor dying prior to the termination of the trust is remote.

Qualified Personal Residence Trusts

A qualified personal residence trust (QPRT) is a vehicle whereby the donor gifts his home to a trust reserving the right to live in the home for a fixed number of years. After the term of the trust is complete, the donor’s beneficiaries, generally the children, will have ownership of the home. The donor can continue to live in the home after the termination of the trust, but must pay rent to the children at a fair market value rental rate, which is also another technique used to reduce the donor’s estate. The advantage of the QPRT is the delay in the gift, so that the value of the remainder interest is the amount of the taxable gift. Depending on the term of the trust, the taxable gift is generally a fraction of the current fair market value of the home. If each the husband and wife transfer a one-half interest in the home to separate QPRTs, a discount for a fractional interest could be warranted.

If the home is sold and not replaced or destroyed and not replaced, the trust turns into a GRAT as previously described, and the donor must receive an annuity. Again, if the donor dies during the term of the trust, the value of the trust assets will be included in his estate. A taxpayer is allowed to create two QPRTs during his life, one for his primary residence and one for another personal residence. The disadvantage to the beneficiaries is that the basis of the residence is the carryover basis equal to the donor’s cost basis.

Charitable Trusts

Charitable Remainder Annuity Trust and Charitable Remainder Unitrust
A charitable remainder annuity trust (CRAT) is similar to a GRAT except the remainder interest is transferred to a qualified charitable organization at the end of the term. If set up during life time, the donor will receive a charitable income tax deduction for the value of the remainder interest given to charity. The donor must receive an annuity of not less than 5% for the life of himself or with other beneficiaries, or for a term which cannot exceed twenty years. No additional contributions can be made to the trust. If the donor does not have any children, this might be setup at death, with his spouse receiving the annuity for her life and the remainder to charity. The value of the annuity will qualify for the estate tax marital deduction and the remainder value of the CRAT will qualify for the estate tax charitable deduction, avoiding any estate tax.

A charitable remainder unitrust (CRUT) is similar to a CRAT except that the trust is valued annually and the annuity is recomputed each year. The CRAT has a fixed annuity and the CRUT annuity will vary each year. Unlike a CRAT, the donor can make additional contributions to a CRUT. If the donor dies without a surviving spouse, the value of the trust assets will be included in the donor’s estate, however, the donor will receive a charitable deduction for estate tax purposes, escaping any estate tax on the value of the CRAT or CRUT.

One of the benefits of the CRAT or CRUT is that the trust is exempt from income tax. If the donor transfers an asset with a low cost basis, the trust can sell the asset and pay no income tax. This is a popular technique when the asset is not producing any income and the donor wants to reinvest the assets into income producing assets. The annuity paid to the donor will be taxable to the donor with ordinary income taxed first, such as interest, dividends and short-term capital gains, then long-term capital gains and finally tax exempt income.

This taxation structure avoids the taxation of the entire gain in the year of sale and defers the taxation until each annuity is paid. Some taxpayers will buy additional life insurance equal to the value of assets transferred to the CRAT or CRUT, with the children as beneficiaries to make up the amount that was transferred to charity. If structured without incidents of ownership to the donor and insured, the life insurance will not be included in the donor’s estate.

Charitable Lead Trusts
A charitable lead trust is a trust set up for a term of years with a fixed amount or fixed percentage payable to one or more charitable organizations. After the trust terminates at the end of the term, the remainder will be payable to beneficiaries, generally younger family members of the donor. This effectively enables the donor to benefit charity and retain the asset in the donor’s family. The trust can be set up as a charitable lead annuity trust (CLAT) with a fixed annuity, or a charitable lead unitrust (CLUT) with the trust revalued annually. The trust can be set up during the donor’s life-time or at the donor’s death. If set up during life-time, in order to receive a charitable income tax deduction, the donor must be considered the owner of the trust under the grantor trust rules. The donor would be taxed on the income of the trust and receive a charitable income tax deduction equal to the present value of the income interest payable to the charity. An alternative to this structure is to set up the trust as a nongrantor trust. The donor will not receive an income tax deduction, but he will also not be taxed on the trust’s income each year. The trust pays the tax on its taxable income but the trust also receives an income tax deduction for the annuity paid to the charity.

Because a taxable gift occurs in the year the trust is created, equal to the present value of the remainder interest which will be transferred to the donor’s beneficiaries, these types of trusts are not as widely used. If the trust is set up at the time of his death, the donor’s estate will receive an estate tax deduction equal to the present value of the income interest paid to the charity. Depending on the term of the trust and current interest rate, a substantial charitable estate deduction can be taken by the estate in computing the donor’s taxable estate. For instance, if a CLAT was created on death in December 2001 with $10,000,000 for a term of twenty years with a 5% annuity, the donor’s estate would receive an estate tax deduction in the amount of $8,669,550. This technique is widely used by high net worth taxpayers, especially when their children have substantial assets of their own. If the trust out performs the annuity rate, the accumulated income plus the principal will pass to the beneficiaries. The assets can also be transferred to grandchildren, but there are special rules relating to the allocation of the generating skipping exemption to a CLAT, which doesn’t apply to a CLUT.

Gift Annuities
Another charitable gift option that is similar to a charitable remainder annuity trust is a gift annuity. Under a gift annuity, the donor transfers assets to the charity in exchange for a promise to pay the donor an annuity for life. The donor will receive a charitable income tax deduction equal to the assets transferred less the present value of the annuity payments. The transfer is treated as a bargain sale to the charity, so that a transfer of appreciated assets will create a taxable transaction. If the asset is a long-term capital asset, a portion of the annuity payment will be treated as long-term capital gain. The remainder of the payment will be considered principal and interest.

Trusts

Credit Shelter Trusts AND Marital Trusts
A valuable estate planning tool is the use of the marital deduction when the decedent has a surviving spouse. There is an unlimited marital deduction available to the decedent for assets given outright or in trust. To ensure that the decedent’s assets will eventually transfer to the beneficiaries of the decedent’s choice, the assets are often times transferred to a trust for the benefit of the surviving spouse. To qualify for the marital deduction for assets transferred to the trust, the estate must make an election, and the trust must be required to distribute the income at least annually for the life of the surviving spouse. No other person can have an interest in the trust until the death of the surviving spouse. This trust is known as a marital deduction qualified terminable interest trust (QTIP). The trust can contain a discretionary power to make principal payments based on the needs of the surviving spouse.

In order to utilize the decedent’s lifetime estate tax exemption, the remainder is generally transferred to a credit shelter trust or bypass trust. The amount transferred generally is the amount of the decedent’s unused lifetime estate tax exemption. Many times the terms of the trust is the same as the marital trust, but this trust is not required to distribute income or principal to the surviving spouse.

Life Insurance Trusts
Life insurance is a valuable estate planning tool, which can be used to create more wealth on death or used to pay the estate tax on larger estates with illiquid assets. If the life insurance was owned by the decedent on death, the life insurance proceeds would be includable in the decedent’s taxable estate. Therefore, the life insurance is often purchased by an irrevocable trust with an independent unrelated trustee, so that the decedent will not have any incidents of ownership in the life insurance. Upon death, the life insurance is received by the trust and can be distributed to the beneficiaries to pay the estate tax. Alternatively, if the trust is not to terminate at the decedent’s death, the trust could loan the money to the estate or purchase illiquid assets from the estate.

The grantor will have to transfer sufficient income producing assets to the trust to pay for the annual premiums. The transfer would be considered a completed gift for gift tax purposes. To qualify for the gift tax annual exclusion of $13,000, the beneficiaries of the trust must have a present interest in the trust. Instead of transferring sufficient assets to the trust to pay the premiums, the grantor usually will transfer an amount equal to the annual premium. The trust terms will give multiple beneficiaries the right to withdraw the amount transferred for a short period time the equal to the annual exclusion amount or less, depending on the amount of the premiums. This limited power to withdraw by the beneficiaries is known as a “Crummey Power”. Because the income of the trust can be used to pay life insurance premiums, the trust will be treated as a grantor trust with income taxed to the grantor.

Dynasty Trusts
A few states have enacted new statutes that will allow a trust to remain in existence on a perpetual basis, which is known as a “dynasty trust”. Prior to the new statutes, the trust was required to terminate after the death of a person living at the time of creation of the trust plus 21 years, known as the “rule against perpetuities”. Many states still have the rule against perpetuities in effect. Missouri has abolished the rule against perpetuities, and therefore, a grantor can set up a trust to benefit not only his children and grandchildren, but also future generations. As long as the grantor has sheltered the trust from generation skipping tax by utilization of his lifetime generation skipping tax exclusion ($5,000,000 in 2011 and $5,120,000 in 2012), the trust will avoid any future federal estate tax. In addition to the estate tax benefit, the trust will provide protection against judgments from lawsuits, including bankruptcy and divorce, of the trust beneficiaries.

Revocable Trusts
Inter vivos revocable trusts, also known as living trusts, are the most commonly used trusts in estate planning. The grantor has control over the trust during his lifetime and can revoke the trust or amend it as many times as he likes. Many times the will is drafted so that if some assets are not titled in the name of the trust, these assets will “pour over” to the trust at the grantor’s death. The living trust will contain the dispositive provisions similar to a will. There is no income or estate tax benefits by setting up the revocable trust because the grantor will be taxed on the income from the trust assets, and the assets will be included in his estate upon death.

There are many benefits to the inter vivos revocable trust. The assets will avoid probate which is slow and costly. The trust will have uninterrupted trust administration after the grantor’s death. Since the trust assets will not be probated, the trust will avoid publicity unlike that of assets subject to probate through a will. If the grantor becomes incompetent or incapacitated, the successor trustee can take over the administration of the trust without interruption. If the grantor is the trustee, the trust will not be required to have a separate federal ID number or file a separate income tax return.

We hope that the information in this article is useful in your gift and estate planning. If you wish to take advantage of any of the planning techniques that we have described, please feel free to call.

Written by Brenda Logsdon, CPA. Brenda is a partner at The Whitlock and has worked in public accounting with a specialization in taxation since 1975. She has significant experience in tax strategy planning regarding mergers and acquisitions and serves as practice partner-in-charge of income, gift and state taxation. Brenda provides planning and consulting services for clients in a variety of industries including not-for-profit organizations, financial institutions, wholesale and retail distribution, manufacturing, medical practices, construction and real estate development companies. She also provides tax planning for complex corporations, partnerships and trusts.

Records
Initially, you will need to gather your records for 2011. A helpful jumping-off point is to review your 2010 return. Your personal situation may be unchanged from when you filed your 2010 return or it may have changed significantly. Either way, your 2010 return is a good vantage point for assembling the materials you will need to prepare your 2011 return.

If you need a copy of your previous year(s) return information, you have several options. You can order a copy of your prior-year return. Alternatively, you may order a tax return transcript or a tax account transcript. A tax return transcript shows most line items from your return as it was originally filed, including any accompanying forms and schedules. However, a tax return transcript does not reflect any changes you or the IRS made after the return was filed. A tax account transcript shows any later adjustments you or the IRS made after the tax return was filed.

If you changed your name as a result of marriage or divorce since you filed your 2010 return, you must advise the IRS. Your name as it appears on your return needs to match the name registered with the Social Security Administration. A mismatch will likely delay the processing of your return.

Forms W-2
Many taxpayers cannot begin preparing their 2011 income tax returns until they have their Forms W-2, Wage and Tax Statement. Employers have until January 31, 2012 to send you a 2011 Form W-2 earnings statement. If you do not receive your W-2 by the deadline, contact your employer. If you do not receive your W-2 by mid-February, contact the IRS. You still must file your return or request an extension to file even if you do not receive your Form W-2. In certain cases, you may be able to file Form 4852, Substitute for Form W-2, Wage and Tax Statement.

Filing deadline
April 15, 2012 is a Sunday. Returns would normally be due the next day, April 16, 2012. However, April 16 is a holiday in the District of Columbia (Emancipation Day). As a result, the due date for 2011 returns is April 17, 2012. If the mid-April tax deadline clock runs out, you can get an automatic six-month extension of time to file through October 17. However, this extension of time to file does not give you more time to pay any taxes due. To obtain an extension, you need to file Form 4868, Application for Automatic Extension of Time to File U.S. Individual Income Tax Return.

Casualty losses
Many taxpayers experienced family, business and personal losses from hurricanes, tropical storms, wild fires, floods, and other natural disasters in 2011. For federal tax purposes, a casualty loss can result from the damage, destruction or loss of your property from any sudden, unexpected, or unusual event such as a hurricane, tornado, fire, or other disaster.

Casualty losses are generally deductible in the year the casualty occurred. However, if you have a casualty loss from a federally-declared disaster, you can choose to treat the loss as having occurred in the year immediately preceding the tax year in which the disaster happened. This means you can deduct a 2011 loss on your 2011 return or amended return for that preceding tax year (2010). If you have any questions about a casualty loss, please contact our office.

Retirement savings
Just because the calendar moved from 2011 to 2012 doesn’t necessarily mean you missed out on contributing to a retirement savings plan. You can contribute up to $5,000 to a traditional IRA for 2011 and you can make the contribution as late as April 17, 2012. However, if you or your spouse is covered by an employer retirement plan, this will affect how much, if any, of your contribution is tax deductible. Individuals age 50 and older may qualify for a catch-up contribution of $1,000 on top of the $5,000 maximum. Different rules apply to other types of retirement savings plans. Our office can review these rules in detail with you.

IRS Fresh Start Initiative
In 2011, the IRS announced a new program, called the Fresh Start Initiative, to help distressed taxpayers. The IRS adjusted its lien policies, increased the dollar threshold when liens are generally issued, made it easier for taxpayers to obtain lien withdrawals, and extended the streamlined offer-in-compromise program. Previously, the IRS had given its employees greater authority to suspend collection actions in certain hardship cases where taxpayers are unable to pay. This includes instances where a taxpayer has recently lost a job, is relying solely on Social Security, or is paying significant medical bills.

If you are experiencing hardship, the most important thing you can do is to remain in compliance with your tax obligations. If you owe back taxes, now is the time to pay them, if possible, or enter into an installment agreement, if you qualify, with the IRS. The IRS wants to see you making a good faith effort to pay your taxes.

Tax law changes
Along with assembling records and reviewing activities in 2011, it’s a good idea to review some of the tax law changes in 2011 that may affect your return. Our office can review your 2010 return and see which areas may have been affected by tax law changes for your 2011 return. In some cases, popular tax incentives that were available in 2010 were extended into 2011. You don’t want to miss out on any available tax breaks.

If you have any questions about preparing for the 2012 filing season, please contact our office.

As the year 2011 is coming to an end, taxpayers search for available credits to reduce their upcoming taxable income. A credit that may be overlooked is the New Hire Retention Tax Credit. You may have already taken a payroll tax credit in 2010 when some of these eligible employees were initially hired, but there’s more to it.

This additional credit was part of the Hiring Incentives to Restore Employment Act of 2010 (HIRE). The credit is a general business credit to encourage the retention of new hires. The employer may claim a credit of up to $1,000 for each retained worker who is a qualified employee. There is no limit on the number of qualified retained employees. The criteria for a qualified retained employee:

• Must begin work after February 3, 2010 and before January 1, 2011
• Must complete and sign form W-11 declaring that he was employed for a total of 40 hours or less during the 60 day period ending on the date the employment begins
• Is not to be employed to replace another employee, unless the former employee left voluntarily
• Is not related to the employer
• Must have been employed for at least 52 consecutive weeks
• Must have wages during the second 26 weeks of the 52 consecutive week period of at least 80% of the wages for the first 26 weeks of the 52 consecutive week period

 The credit is available in the first taxable year the 52 consecutive week requirement is met. For calendar taxpayers, the first eligible year for this credit is tax year 2011. An employer may claim both the payroll tax exemption on wages paid in 2010 (reported on the quarterly federal employment return) and the new hire retention credit on the income tax return for the same employee as long as all requirements are met.

In addition, the credit is available even if the Work Opportunity Tax Credit has been claimed. The credit is calculated on Form 5884-B and the employer claims the credit on Form 3800 to be attached to the employer’s income tax return. The credit is the lesser of $1,000 or 6.2 percent of the employee’s wages paid for the 52 consecutive week period. This credit cannot offset alternative minimum tax but any unused credit may be carried forward 20 years.

If you think you may benefit from this credit, please contact us today.

Written by Melinda Thurman, Staff Accountant

Tips
The IRS has posted tips for deducting charitable contributions on its website. The tips are a good refresher of the fundamental rules for deducting charitable contributions:

• To be tax-deductible, a contribution must be made to a qualified organization
• To deduct a charitable contribution, you must file Form 1040 and itemize deductions on Schedule A
• If you receive a benefit because of your contribution such as merchandise, tickets to a ball game or other goods and services, then you can deduct only the amount that exceeds the fair market value of the benefit received
• Donations of clothing and household items must generally be in good used condition or better to be tax-deductible
• Special rules apply to donations of motor vehicles
• Many donations must be substantiated; the substantiation rules vary for different donations.

Qualified organizations
Some individuals are surprised to learn that their donation is not tax-deductible because the recipient is not a qualified charitable organization. Generally, churches, temples, synagogues, mosques, and other religious organizations are qualified charitable organizations. Nonprofit community service, educational, and health organizations are also generally qualified charitable organizations. Special rules apply to foreign charities. If you have any questions whether the organization is a qualified charitable organization, please contact our office.

Substantiation rules
In 2006, Congress significantly revised the rules for substantiating your charitable contributions. Unless a contribution is properly substantiated, the IRS may deny your deduction.

Regardless of the amount, to deduct a contribution of cash, check, or other monetary gift, you must maintain a bank record, payroll deduction records or a written communication from the organization containing the name of the organization, the date of the contribution and amount of the contribution. Remember, this rule applies to all cash contributions, even contributions of small monetary amounts. The IRS will not accept certain personal records. For example, you cannot substantiate a contribution by reference to a diary or notes made at the time of the donation.

In recent years, text message donations have grown in popularity. For text message donations, a telephone bill will meet the record-keeping requirement if it shows the name of the receiving organization, the date of the contribution, and the amount given.

To claim a deduction for contributions of cash or property equaling $250 or more you must have a bank record, payroll deduction records or a written acknowledgment from the qualified organization showing the amount of the cash and a description of any property contributed, and whether the organization provided any goods or services in exchange for the gift.

One document may satisfy both the written communication requirement for monetary gifts and the written acknowledgement requirement for all contributions of $250 or more. If your total deduction for all noncash contributions for the year is over $500, you must complete and attach IRS Form 8283, Noncash Charitable Contributions, to your return.

Additional rules apply for donations valued at more than $5,000. These donations generally require an appraisal and you must advise the IRS of that appraisal by filing a special form.

Expiring provisions
Under current law, certain IRA owners can directly transfer tax-free, up to $100,000 annually from the IRA to a qualified charitable organization. The benefit is limited. The IRA owner must be age 70 ½ or older. Additionally, the contribution does not qualify for the deduction for charitable donations. To qualify, the IRA funds must be contributed directly by the IRA trustee to the qualified charitable organization. You can also take advantage of this tax incentive if you itemize or do not itemize deductions.

Unless extended, this incentive is scheduled to expire after December 31, 2011. It is unclear if Congress will extend the incentive into 2012 or beyond. If you are considering a charitable contribution from your IRA, please contact our office so we can review the rules in detail.

Several other enhanced charitable giving incentives are also scheduled to expire at the end of 2011. They include special rules for contributions of food inventory, contributions of computer equipment to schools by corporations, and other special rules for corporations.

Clothing and household items
Cleaning out your closet can help generate year-end tax savings. However, not all charitable contributions of clothing and household items are deductible. Generally, clothing and household items donated to a charitable organization must be in good used or better condition. Other rules also apply to donations of clothing and household items.

Motor vehicles and other types of donations
The tax deduction for a motor vehicle, boat or airplane donated to charity is fraught with complexity. The substantiation requirements depend on the amount of your claimed deduction. If you are considering donating a motor vehicle, boat or airplane to charity, please contact our office so we can help you navigate the substantiation rules to maximize your tax benefits.

The rules for donations of conservation easements, intellectual property and other items likewise require expert planning. Otherwise, you could miss the tax benefit.

Limitations
The Tax Code includes a number of provisions limiting tax-deductible contributions. Limitations may be based on the individual’s income, the type of donation and the nature of the recipient organization. Our office can describe how these limitations may impact you.

In past years, a provision known as the limitation on itemized deductions applied to higher-income individuals. This provision reduces the total amount of a higher-income individual’s otherwise allowable deductions; however, some deductions are not impacted. For 2011 and 2012, this limitation does not apply.

If you have any questions about the mechanics of tax-deductible charitable contributions, please contact our office.

Thanks to legislation enacted at the end of 2010, tax rates are stable for 2011 and 2012, although the uncertainty will return as 2013 approaches, as political pressure in Washington builds to do something quickly for the economy. Ordinary income tax rates for individuals currently are 10, 15, 25, 28, 33 and 35 percent; capital gains rates are zero and 15 percent.

President Obama has proposed to preserve these tax rates for taxpayers with income below $200,000 (individuals) and $250,000 (married couples filing jointly) and to raise the rates for taxpayers in these higher-income brackets. If Congress is gridlocked and takes no action, everybody’s rates will rise, but again, not until 2013.

Expiring tax breaks
Unfortunately, not all is quiet on the tax front despite no dramatic rate changes until 2013. There are some specific tax provisions that will terminate at the end of 2011, unless Congress and the President agree to extend them. These include the tuition and fees above-the-line deduction for high education expenses, which can be as high as $4,000. Another expiring provision is the deduction for mortgage insurance premiums, which covers premiums paid for qualified mortgage insurance.

Several other benefits (“extenders”) are also scheduled to expire after 2011:

• The state and local sales tax deduction
• The classroom expense deduction for teachers
• Non-business energy credits
• The exclusion for distributions of up to $100,000 from an IRA to charity
• A higher deduction limit for charitable contributions of appreciated property for conservation purposes

Retirement accounts
An old standby that makes sense from year-to-year is maximizing contributions to an IRA. The contribution is deductible up to $5,000 ($6,000 for taxpayers over 50), depending on some specific taxpayer income levels and circumstances. Taxpayers in a 401(k) plan can reduce their income by contributing to their employer plan, for which the limit in 2011 is $16,500.

In 2010, it was particularly important to consider whether to convert a traditional IRA to a Roth IRA, because the income realized on conversion could be recognized over two years. While a conversion continues to be worthwhile to consider (because distributions from a Roth IRA are not taxable), there are no longer any special break to defer a portion of the income from the conversion.

Alternative minimum tax
The AMT has been “patched” for 2011. The exemptions have been temporarily increased from the normal statutory levels to the “patched” levels:

• From $33,750 to $48,450 for single individuals
• From $45,000 to $74,450 for married couples filing jointly and surviving spouses
• From $22,500 to $37,335 for married couples filing separately

The amounts return to the “normal levels” of $33,750/$45,000/$22,500, respectively, in 2012 unless Congress takes action to maintain the patch. Elimination of the AMT is a goal of long-term tax reform, but the loss of revenue has been considered too high in the past. Without the “patch,” the Congressional Budget Office estimates that an additional 20 million middle-class taxpayers would suddenly become subject to an AMT once designed only for millionaires.

While planning for the AMT is difficult, taxpayers may want to consider realizing AMT income, such as capital gains, in 2011, when the patch is higher, rather than in 2012.

Conclusion
Taxpayers can take advantage of 2011 provisions to realize last-minute tax benefits. Some of these benefits may not be available in 2012. It is worthwhile to look at these planning opportunities as part of an overall year-year financial strategy.

As part of this commitment, we are including a link to the Estate Planning Guide to highlight the need for estate planning and estate-planning strategies. This guide incorporates provisions of recent tax changes and shows how to take advantage of them to maximize the benefit to your heirs and minimize taxes. Please click here to view the guide.

The expert advice of a professional advisor cannot be substituted. The estate planning ideas in this booklet are offered as suggestions only. As you begin to consider your estate planning needs, we encourage you to contact us concerning your specific situation while developing your estate plan.

We welcome the opportunity to provide you with expert guidance and help your heirs benefit from effective planning. Call to schedule an appointment and discuss your situation with our qualified professionals and create a bright future today.

Taxpayers are required to keep accurate, permanent books and records so as to be able to determine the various types of income, gains, losses, costs, expenses and other amounts that affect their income tax liability for the year. The IRS generally does not require taxpayers to keep records in a particular way, and recordkeeping does not have to be complicated. However, there are some specific recordkeeping requirements that taxpayers should keep in mind throughout the year.

Business Expense Deductions

A business can choose any recordkeeping system suited to their business that clearly shows income and expenses. The type of business generally affects the type of records a business needs to keep for federal tax purposes. Purchases, sales, payroll, and other transactions that incur in a business generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. Supporting documents for business expenses should show the amount paid and that the amount was for a business expense. Documents for expenses include canceled checks; cash register tapes; account statements; credit card sales slips; invoices; and petty cash slips for small cash payments.

The Cohan rule. A taxpayer generally has the burden of proving that he is entitled to deduct an amount as a business expense or for any other reason. However, a taxpayer whose records or other proof is not adequate to substantiate a claimed deduction may be allowed to deduct an estimated amount under the so-called Cohan rule. Under this rule, if a taxpayer has no records to provide the amount of a business expense deduction, but a court is satisfied that the taxpayer actually incurred some expenses, the court may make an allowance based on an estimate, if there is some rational basis for doing so.

However, there are special recordkeeping requirements for travel, transportation, entertainment, gifts and listed property, which includes passenger automobiles, entertainment, recreational and amusement property, computers and peripheral equipment, and any other property specified by regulation. The Cohan rule does not apply to those expenses. For those items, taxpayers must substantiate each element of an expenditure or use of property by adequate records or by sufficient evidence corroborating the taxpayer’s own statement.

Individuals

Record keeping is not just for businesses. The IRS recommends that individuals keep the following records:

• Copies of Tax Returns. Old tax returns are useful in preparing current returns and are necessary when filing an amended return.
• Adoption Credit and Adoption Exclusion. Taxpayers should maintain records to support any adoption credit or adoption assistance program exclusion.
• Employee Expenses. Travel, entertainment and gift expenses must be substantiated through appropriate proof. Receipts should be retained and a log may be kept for items for which there is no receipt. Similarly, written records should be maintained for business mileage driven, business purpose of the trip and car expenses for business use of a car.
• Business Use of Home. Records must show the part of the taxpayer’s home used for business and that such use is exclusive. Records are also needed to show the depreciation and expenses for the business part of the home.
• Capital Gains and Losses. Records must be kept showing the cost of acquiring a capital asset, when the asset was acquired, how the asset was used, and, if sold, the date of sale, the selling price and the expenses of the sale.
• Basis of Property. Homeowners must keep records of the purchase price, any purchase expenses, the cost of home improvements and any basis adjustments, such as depreciation and deductible casualty losses.
• Basis of Property Received as a Gift. A donee must have a record of the donor’s adjusted basis in the property and the property’s fair market value when it is given as a gift. The donee must also have a record of any gift tax the donor paid.
• Service Performed for Charitable Organizations. The taxpayer should keep records of out-of-pocket expenses in performing work for charitable organizations to claim a deduction for such expenses.
• Pay Statements. Taxpayers with deductible expenses withheld from their paychecks should keep their pay statements for a record of the expenses.
• Divorce Decree. Taxpayers deducting alimony payments should keep canceled checks or financial account statements and a copy of the written separation agreement or the divorce, separate maintenance or support decree.

Don’t forget receipts. In addition, the IRS recommends that the following receipts be kept:

• Proof of medical and dental expenses
• Form W-2, Wage and Tax Statement, and canceled checks showing the amount of estimated tax payments
• Statements, notes, canceled checks and, if applicable, Form 1098, Mortgage Interest Statement, showing interest paid on a mortgage
• Canceled checks or receipts showing charitable contributions, and for contributions of $250 or more, an acknowledgment of the contribution from the charity or a pay stub or other acknowledgment from the employer if the contribution was made by deducting $250 or more from a single paycheck
• Receipts, canceled checks and other documentary evidence that evidence miscellaneous itemized deductions
• Pay statements that show the amount of union dues paid.

Electronic Records/Electronic Storage Systems

Records maintained in an electronic storage system, if compliant with IRS specifications, constitute records as required by the Code. These rules apply to taxpayers that maintain books and records by using an electronic storage system that either images their hard-copy books and records or transfers their computerized books and records to an electronic storage media, such as an optical disk.

The electronic storage rules apply to all matters under the jurisdiction of the IRS including, but not limited to, income, excise, employment and estate and gift taxes, as well as employee plans and exempt organizations. A taxpayer’s use of a third party, such as a service bureau or time-sharing service, to provide an electronic storage system for its books and records does not relieve the taxpayer of the responsibilities described in these rules. Unless otherwise provided under IRS rules and regulations, all the requirements that apply to hard-copy books and records apply as well to books and records that are stored electronically under these rules.

Call us if you have any questions about record keeping.