Gift Opportunity for Depressed Securities

Posted on October 16, 2008 by Ronnie McClure

With the meltdown and continued volatility in the financial markets comes a potentially favorable wealth transfer tax strategy. Lifetime gifts of stock and securities at depressed market values can transfer future appreciation out of your estate and to lower generations as the securities recover their value.

For 2008, an individual may transfer $12,000 transfer and generation-skipping tax-free to an unlimited number of individuals. A married couple may transfer $24,000 without regard to which spouse’s name is on the securities. For example, a couple with four children and six grandchildren may transfer $240,000 at current market values to their family. Doing so moves all future appreciation, including a market recovery in this value, to future generations. These transfers will be free of any transfer tax and will not require filing a gift tax return.

For 2009, the amounts increase to $13,000 per individual and $26,000 for a couple.  Therefore, the same family may transfer an additional $260,000 of depressed securities to lower generation family members in January. The couple will then have moved $500,000 at current market value, and all future appreciation, out of their estates in a period of just over 45 days with no tax consequences.

Keep in mind that the income on these securities, interest or dividends for example, earned by a child who has not attained age 18 by the end of the tax year will generally be taxed at the child’s parents highest marginal tax rate. This does not include capital gains, however, when the securities are sold.

These gifts are not a slam-dunk decision, however. It is necessary to consider how capital gains will be taxed when the securities appreciate and are subsequently sold. 

Generally, a donor’s tax basis in gifted property carries over to the donee. Under this general rule, for example, if a couple transfers’ securities having a market value of $125,000 and a tax basis of $100,000 to a child, the child’s tax basis in those securities is also $100,000.  A subsequent sale of the securities at $125,000 results in a $25,000 capital gain that is taxed to the child. If the parents have held the stock for at least one year, the gain will be long-term capital gain to the child, even if sold immediately. In other words, the parents’ holding period of the securities "tacks" to the holding period of the child. That’s the general rule for appreciated property; special "dual basis" rules apply to gifts of property when the fair market value is less than the donor’s basis. This “dual basis” should give some pause in planning gifts of depreciated property.

Under the dual basis rule, the donee’s basis for determining loss in depreciated property is the lesser of the donor’s basis or fair market value on the date of the gift if the property is subsequently sold at a value less than the donor’s basis on the date of sale. Assume that a couple transfers securities having a market value of $90,000 and a tax basis of $100,000 to a child. The child subsequently sells the securities at their $90,000 fair market value. In this case, the child recognizes no gain or loss; the child’s basis is $90,000, and $10,000 of the parents’ basis has fallen through the cracks. In a like manner, assume the value of the securities continues to decline and are sold for $50,000. The child has a capital loss of $40,000 ($50,000 sales price less $90,000 basis) and, again, $10,000 of the parent’s basis has disappeared.

Assume, however, that the value of the securities fully recovers and continues to appreciate to a value of $150,000 at the time the child sells them. Here, the value is greater than the parents’ basis resulting in real gain. Now the child’s basis for determining taxable gain is the same $100,000 as it was in the hands of her parents and the child recognizes a gain of only $50,000.

The bottom line is that there are several considerations in gifting depreciated property. If you expect that the property will fully recover its value and continue to appreciate over the long-term, a gift now of securities at depressed value makes a lot of sense from the standpoint of estate tax planning. If you believe that the securities will recover some value before being sold, but not up to the level of the donor’s basis, you may need to consider the loss in basis that might occur. It may be more appropriate to sell the securities yourself, recognize the full loss, gift the cash proceeds to the child, and have the child reinvest the cash. I recommend the child postpone reinvestment in the same or substantially similar securities for 30 days to avoid possible application of the "wash sale" rule and the parents’ loss disallowed.

If you have specific questions concerning estate planning, please contact me at response@phdcpa.com or call me at 214.957.3366.

Ronnie

© 2008 Ronnie C. McClure, PhD, CPA

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Main Street Tax Provisions in Financial Markets Bill

Posted on October 3, 2008 by Ronnie McClure

The House of Representatives passed the “rescue” legislation this afternoon. The president immediately stated that he would sign the bill as soon as it reaches his desk. My copy of the bill submitted to the House for consideration is 451 pages. The following is a very brief highlight of the tax provisions affecting Main Street individuals, businesses, and charitable organizations contained in the bill.

PROVISIONS AFFECTING INDIVIDUALS:

  • Extension for tax year 2008 and increase in AMT exemption amount from $66,250 to $69,950 for married joint returns and surviving spouses; $33,125 to $34,975 for married filing separately; $44,350 to $46,200 for single taxpayers.
  • Increase in the amount of AMT tax carryovers from certain prior years that can be applied to reduce regular income tax.
  • Abatement of penalty and interest on underpayment of AMT related to Incentive Stock Options for all prior years.
  • Deduction for state and local sales taxes extended through 2010.
  • Deduction for tuition and related expenses extended through 2009.
  • Deduction for certain expenses of elementary and secondary school teachers extended through 2009.
  • Extension of additional itemized deduction for real property taxes of non-itemizer taxpayers extended through 2009.
  • Eight-thousand five-hundred income threshold used to calculate refundable portion of child tax credit (reduction from $10,000).

PROVISIONS AFFECTING BUSINESSES:

  • Research tax credit extended and increased through 2009.
  • Extension of 15-year straight-line cost recovery for qualified leasehold improvements extended through 2010.
  • Fifteen-year straight-line cost recovery for new construction of qualified restaurant improvements placed in service in 2009.
  • Fifteen-year straight-line cost recovery for certain improvements to retail space placed in service in 2009.
  • Seven-year cost recovery period for motorsports racing track facility through 2009.
  • Certain farming business machinery and equipment treated as 5-year property placed in service before 2010

PROVISIONS AFFECTING CHARITABLE ORGANIZATIONS:

  • Tax-free distributions from individual retirement plans for charitable purposes extended through 2009.
  • Favorable tax treatment of certain payments to controlling exempt organizations extended through 2009.
  • Decrease in basis adjustment to stock of S corporations making charitable contributions of property extended through 2009.
  • Enhanced deduction for qualified computer contributions extended through 2009.
  • Enhanced charitable deductions for contributions of food inventory extended through 2009.
  • Enhanced charitable deduction for contributions of book inventory extended through 2009.

SPECIAL PROVISIONS

There are provisions, not necessarily affecting Main Street, dealing with:

  • Compensation of executives of firms that participate in the rescue program.
  • The coal industry and carbon mitigation (study ordered of the Internal Revenue Code on provisions related to carbon mitigation).
  • Transportation and renewable fuels (including provision to permit non-taxable fringe benefits to bicycle commuters).
  • Increase and extension for one year of the tax credit for biodiesel and renewable diesel fuels for all taxpayers.
  • A new credit for owners of plug-in electric cars ($2,500 plus an amount for excess battery storage capacity) with higher amounts for vehicles of greater weight.
  • Federally designated disaster areas impacted by Midwest flooding and Hurricane Ike.

This is only a brief summary of the tax provisions of the bill. If you have specific questions concerning this new and important legislation and how they will affect you, please contact me at response@phdcpa.com or call me at 214.957.3366.

Ronnie

© 2008 Ronnie C. McClure, PhD, CPA

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Rescue the Rescue

Posted on October 1, 2008 by Ronnie McClure

Several of my clients and friends have asked my opinion on the “bailout.” I have held my comments because, even though I have a degree in Economics, I am not an economist; I am a CPA, but I don’t regard myself as an accountant; I am an investment advisor and licensed to sell financial products, but I am not a expert on Wall Street investments. The only thing that I claim to be anything of an expert in is federal tax law (and certainly not all areas of that), which comes from the PhD and thirty plus years of practice.

My opinion on the financial crisis (I regret that this situation was ever called a bailout) was perfectly expressed yesterday by Thomas L. Friedman in an Op-Ed piece in the New York Times. In case you missed it, I have reproduced it below. My own comments are in brackets. I have read four of his five books and I’m reading the fifth one now. I don’t always agree with him, but I truly respect his opinion.

“Rescue the Rescue
By THOMAS L. FRIEDMAN
Published: September 30, 2008
[The New York Times; Retrieved from the online edition.]

“I was channel surfing on Monday, following the stock market’s nearly 800-point collapse, when a commentator on CNBC caught my attention. He was being asked to give advice to viewers as to what were the best positions to be in to ride out the market storm. Without missing a beat, he answered: ‘Cash and fetal.’

“I’m in both — because I know an unprecedented moment when I see one. I’ve been frightened for my country only a few times in my life: In 1962, when, even as a boy of 9, I followed the tension of the Cuban missile crisis; in 1963, with the assassination of J.F.K.; on Sept. 11, 2001; and on Monday, when the House Republicans brought down the bipartisan rescue package.

“But this moment is the scariest of all for me because the previous three were all driven by real or potential attacks on the U.S. system by outsiders. This time, we are doing it to ourselves. This time, it’s our own failure to regulate our own financial system and to legislate the proper remedy that is doing us in.

“I’ve always believed that America’s government was a unique political system — one designed by geniuses so that it could be run by idiots. I was wrong. No system can be smart enough to survive this level of incompetence and recklessness by the people charged to run it.

“This is dangerous. We have House members, many of whom I suspect can’t balance their own checkbooks, rejecting a complex rescue package because some voters, whom I fear also don’t understand, swamped them with phone calls. I appreciate the popular anger against Wall Street, but you can’t deal with this crisis this way.

“This is a credit crisis. It’s all about confidence. What you can’t see is how bank A will no longer lend to good company B or mortgage company C. Because no one is sure the other guy’s assets and collateral are worth anything, which is why the government needs to come in and put a floor under them. Otherwise, the system will be choked of credit, like a body being choked of oxygen and turning blue.

“Well, you say, ‘I don’t own any stocks — let those greedy monsters on Wall Street suffer.’ You may not own any stocks, but your pension fund owned some Lehman Brothers commercial paper and your regional bank held subprime mortgage bonds, which is why you were able refinance your house two years ago. And your local airport was insured by A.I.G., and your local municipality sold municipal bonds on Wall Street to finance your street’s new sewer system, and your local car company depended on the credit markets to finance your auto loan — and now that the credit market has dried up, Wachovia bank went bust and your neighbor lost her secretarial job there.

“We’re all connected.” [We all form a system. Actually, lots of systems that combine in many various ways, but that discussion is for another time and forum.] “As others have pointed out, you can’t save Main Street and punish Wall Street anymore than you can be in a rowboat with someone you hate and think that the leak in the bottom of the boat at his end is not going to sink you, too. The world really is flat. We’re all connected. “Decoupling” is pure fantasy.”

“I totally understand the resentment against Wall Street titans bringing home $60 million bonuses. But when the credit system is imperiled, as it is now, you have to focus on saving the system, even if it means bailing out people who don’t deserve it. Otherwise, you’re saying: I’m going to hold my breath until that Wall Street fat cat turns blue. But he’s not going to turn blue; you are, or we all are. We have to get this right.

“My rabbi told this story at Rosh Hashana services on Tuesday: A frail 80-year-old mother is celebrating her birthday and her three sons each give her a present. Harry gives her a new house. Harvey gives her a new car and driver. And Bernie gives her a huge parrot that can recite the entire Torah. A week later, she calls her three sons together and says: ‘Harry, thanks for the nice house, but I only live in one room. Harvey, thanks for the nice car, but I can’t stand the driver. Bernie, thanks for giving your mother something she could really enjoy. That chicken was delicious.’

“Message to Congress: Don’t get cute. Don’t give us something we don’t need. Don’t give us something designed to solve your political problems. Yes, Hank Paulson and Ben Bernanke need to accept strict oversights and the taxpayer must be guaranteed a share in the upside profits from all rescued banks. But other than that, give them the capital and the flexibility to put out this fire.

“I always said to myself: Our government is so broken that it can only work in response to a huge crisis. But now we’ve had a huge crisis, and the system still doesn’t seem to work. Our leaders, Republicans and Democrats, have gotten so out of practice of working together that even in the face of this system-threatening meltdown they could not agree on a rescue package, as if they lived on Mars and were just visiting us for the week, with no stake in the outcome.

“The story cannot end here. If it does, assume the fetal position.” [I couldn’t have said it better myself. Thanks, Tom.]

Ronnie

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New Purchased Equipment Expense Deduction

Posted on September 27, 2008 by Ronnie McClure

I don’t recommend buying equipment solely for the tax benefits. If you need new equipment for your trade or business, buy it and tax whatever tax savings are available. Generally, you receive, at most, an approximately 35 percent tax savings from fully expensing business asset purchases. The Stimulus Act of 2008, however, provides an expensing tax benefit of which you should be aware.

Thanks to this Act, most small businesses, and even moderate-sized businesses that don’t have huge capital equipment needs may be able to fully expense the cost of machinery, equipment, and certain vehicles purchased during all of tax years beginning in 2008. The full expensing deduction may be claimed regardless of when during the year the assets are placed in service. For example, property placed in service on the last day of the 2008 tax year may be eligible for the full expensing deduction. In addition, the Act increased the amount of the expensing deduction for 2008 to $250,000 and this amount is reduced only when $800,000 of expensing-eligible property is placed in service during the year. These two amounts decline to $133,000 and $530,000 for tax years beginning in 2009 unless the law is changed to further stimulate the economy. Be aware that this deduction is further limited to the trade or business income of the business entity computed before the deduction. In other words, the deduction cannot produce a net operating loss for the business enterprise. This provision does not apply to estates and trusts.

The expensing election is found under section 179 of the Internal Revenue Code. It permits full expensing of qualified purchases up to the stated limits rather than requiring depreciation of those purchases over several years. For unincorporated taxpayers, or taxpayers operating through pass through entities (such as S corporations, partnerships, or limited liability companies taxed as partnerships) there are other benefits. By using the expensing election to lower adjusted gross income, these taxpayers may be able to benefit from itemized deductions or personal exemptions (and other tax benefits) that would otherwise be limited or phased-out because of higher levels of AGI.

The expensing limitations apply at both the entity level and at the taxpayer level. That means, for example, if the sole shareholder of an S corporation receives a $250,000 expensing deduction pass-through from the corporation and he or she also has a $100,000 expensing deduction pass-through deduction from a partnership, he or she may only claim the maximum $250,000 deduction on his or her individual tax return. Any amount of the expensing deduction unused in a given year carries over to future years, subject to the limitations in effect during the carryover year. For these purposes, a husband and wife are treated as one taxpayer.

This favorable provision in the Code is a timing benefit; whether expensed or depreciated, in this year or future years, the full purchase price will result in tax savings. From the standpoint of the time value of money, however, a tax savings generated from qualifying purchases during the remainder of 2008 has more value than tax savings a year or more from now. Therefore, if you are contemplating purchasing business equipment or machinery in the foreseeable future, you may want to determine the benefit of making the acquisition this year, rather than next.

If you have questions concerning the section 179 expensing election, talk to your tax professional or call me at 214.957.3366.

Ronnie

© 2008 Ronnie C. McClure, PhD, CPA

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Preparing the New Form 990 for Tax Year 2008

Posted on September 27, 2008 by Ronnie McClure

As you are probably aware, the Internal Revenue Service announced last year implementation of an extensively revised Form 990 (Return of Organization Exempt from Income Tax) for returns filed in 2009 for the 2008 tax year. The Service has made less substantial changes to Form 990-EZ (Short Form Return of Organization Exempt from Income Tax), but completing it will require more work than in prior years. The bottom line of these changes is that you must budget substantially more time and cost to complete either return. The common “same as last year” answer to many questions on the forms simply will not work any longer.

Let’s briefly review the Short Form changes before moving on to Form 990 itself. The good news is that organizations with gross receipts of less than $1 million and total assets are less than $2.5 million in 2008 may file the Short Form. This is only a phase-in for small organizations, however, because these numbers drop to $500,000 in gross receipts and $1.25 million in total assets in 2009, and $200,000 gross receipts and $500,000 total assets in 2010. For tax year 2007, the Form 990-EZ was simple return with a required Schedule A for public charities totaling 10 pages. Schedule B was used to report donor names for gifts in excess of $5,000. The number of pages required depended on the number and type of gifts required to be reported. For tax year 2008, I estimate that the simple return will now require 15 pages, plus the detail of contributions greater than $5,000. One more thing; the instructions specifically related to the 2007 Short Form required 12 of 68 pages in the instruction booklet for the Form 990. The 2008 Short Form instructions require 93 pages in a book of their own, plus 68 pages of instructions for the separate schedules likely to be required. That makes the total instructions pages jump to 141. These are indeed taxing times for small charitable organizations.

Now let’s turn to the Form 990. For tax year 2007, the basic Form 990 and the required Schedule A for public charities totaled 16 pages. Schedule B was used to report donor names for gifts in excess of $5,000 as with the Short Form. The number of pages required depended on the number and type of gifts. Many question on the basic Form 990 required statements to be attached to the return. A relatively simple return, therefore, may have totaled 20 – 25 pages. I estimate that for tax year 2008 the minimum return will require approximately 38 pages. I also estimate that the number of pages of instructions to complete a simple return has increased to approximately 225. Quite an increase! Plan accordingly.

The new forms are not yet available from the “Forms and Publications” section on the IRS website. The instructions for both the regular Form 990 and the Short Form 990-EZ have been released in final form. The forms themselves are still in draft form. You may download the instructions and draft forms from the main IRS website, www.irs.gov and clicking on the “Charities and Non-Profits” tab and follow the link to the forms themselves. I recommend that you do that to become familiar with the information you will be required to provide.

Whether you prepare your own return or have it prepared by a tax return preparer, someone signs the return under penalties of perjury, and declare that they have examined the return, including accompanying schedules and statements, and to the best of their knowledge and belief, it is true, correct, and complete. That means that the signer is required to know what is in the return. To that end, you may want to register for a free webcast to be broadcast by the IRS on November 4, 2008 from 2 until 3pm EST entitled “Preparing the New Form 990.” To attend, simply go to www.taxtalktoday.tv and register for the program. I recommend that you register now so that on the day of the program you simply logon and watch. I’ll see you there!

Ronnie

© Ronnie C. McClure, PhD, CPA

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IRS Announces Hurricane Ike Relief

Posted on September 18, 2008 by Ronnie McClure

On September 12, the Internal Revenue Service announced that taxpayers “directly affected” by Hurricane Ike would receive an additional 7 days to file corporate tax returns and third-quarter estimated taxes otherwise due on Monday, September 15, 2008. It was not clear from that announcement which taxpayers would be considered “directly affected.” The Service cleared up that announcement today and, as expected, granted those taxpayers even more time to file.

Following the hurricane’s landfall on Saturday, September 13, the federal government declared the following Texas counties a presidential disaster area qualifying for individual assistance: Angelina, Austin, Brazoria, Chambers, Cherokee, Fort Bend, Galveston, Grimes, Hardin, Harris, Houston, Jasper, Jefferson, Liberty, Madison, Matagorda, Montgomery, Nacogdoches, Newton, Orange, Polk, Sabine, San Augustine, San Jacinto, Trinity, Tyler, Walker, Waller and Washington. The Commissioner of the Internal Revenue Service said today that, “We are giving taxpayers in these hard-hit areas until early next year to file their returns and make payments.”

Specifically, today’s relief postpones until January 5, 2009, certain deadlines for taxpayers who reside or have a business in the disaster area. The postponement applies to return filing, tax payment and certain other time-sensitive acts due on or after September 7, 2008, and before January 5, 2009, including individual estimated tax returns and corporate tax returns that were due September 15, and extended individual returns due October 15, 2008.

IRS computer systems will automatically identify taxpayers located in the covered disaster area and apply automatic filing and payment relief. Affected taxpayers who reside or have a business located outside the covered disaster area must call the IRS disaster hotline at 1-866-562-5227 to request tax relief.

If an affected taxpayer receives a penalty notice from the IRS, the taxpayer should call the telephone number on the notice to have the IRS abate any interest and any late filing or late payment penalties that would otherwise apply. Penalties or interest will be abated only for taxpayers who have an original or extended filing, payment or deposit due date, including an extended filing or payment due date, from September 7, 2008, to January 5, 2009.

If you have any questions as to whether you are an “affected taxpayer,” please email me at response@phdcpa.com or call me at 214.957.3366.

Ronnie

© 2008 Ronnie C. McClure

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On the Presidential Candidates’ Tax Plans

Posted on September 5, 2008 by Ronnie McClure

I don’t get too concerned about proposed tax legislation until bills are introduced, debated, and actually get to a joint committee for resolution of differences. What we are hearing today is just rhetoric. Neither candidate will get all they are espousing now. A McCain presidency will have difficulty in maintaining low tax rates, particularly on dividends and capital gains, with both the House and Senate controlled by the Democrats. Whether McCain would have the votes to override a veto of higher tax legislation remains to be seen. Perhaps during the next eight weeks both candidates will put some flesh on the bones of their statements. Obama, to this point, has certainly been more specific than McCain.

Neither candidate specifically addressed transfer taxes (estate, gift, and generation-skipping) in their acceptance speeches. With the need for increased revenue, Congress will not repeal them. Something must be put in place before 2010 estate tax holiday. I believe we are most likely to see continuation of the transfer tax programs in much the same fashion as currently exists, with an individual transfer tax exemption ranging from $3.5 million to $5 million. Carryover of a deceased spouses’ exemption amount to a surviving spouse may be appropriate, but will likely add additional complexity to the Internal Revenue Code, rather than reduce it. Use of a testamentary trust at the first spouses’ death will continue to be appropriate for non-tax reasons, even if not necessary to utilize that spouse’s transfer tax credit. The gift and estate transfer tax exemptions should be re-integrated to a single lifetime exemption as they were before the 2001 tax law changes.

Both candidates will monkey with corporate taxation. Obama will close “loopholes” and likely try to raise the rates. McCain espouses lowering them in order for U.S. corporations to be more competitive worldwide. Obama must realize that a “loophole” is tax “incentive” enacted by Congress to encourage economic behavior. Those incentives become loopholes only when a given taxpayer is unable to take advantage of them. Closing loopholes simply ends economic behavior incentives previously thought to be desirable.

With regard to corporate taxes, both candidates must realize that corporations do not pay taxes; people pay taxes. Which people pay corporate taxes depends on the corporation’s ability to shift the burden of the levy. Very simplistically, a corporation has four alternatives for shifting its tax burden. If a corporation completely absorbs the tax, the burden is shifted to shareholders in the form of lower current or future dividends. The corporation may shift the burden to its customers or clients in the form of higher prices. Employees bear the corporate tax burden if the corporation maintains its revenue, dividends, and investments and cuts (or defers increases) in wages or employee benefits, or cuts jobs. A corporation’s only other alternative to shift the burden is to cut expenses (which are income to someone) and reduce investment in plant, equipment, research, and technology. In these taxing times the public should not be lulled into believing that a corporate tax increase will have no impact on an individual’s economic wellbeing.

The debate is on. It will certainly intensify after November 2 when a new administration is being formed. The year 2009 will be a year of tax law change. The only remaining question is, “Whose ox will get gored?”

Ronnie

© 2008 Ronnie C. McClure

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