Marital actions. As a general rule, attorney’s fees in marital and custody actions are not deductible. This is so even if marital assets include a business or investment property. If legal fees are for tax advice, they are deductible. Also, legal fees paid to protect a certain asset may be added to basis. It is important for the attorney to separately bill for such services. Child support and property settlements incident to a divorce are non-taxable, so related attorney’s fees are nondeductible. Loophole: In the case of a spouse who pays attorney’s fees to secure alimony, the fees are deductible, since the alimony is taxable.
Social security claims. Attorney’s fees to establish a claim to Social Security benefits, (e.g., to qualify for disability payments) are deductible to the extent that the benefits are taxable. Depending on income, up to 85% of benefits may be taxable – so that portion of the fees may be deductible as a miscellaneous itemized deduction.
Criminal actions. Generally, attorney’s fees to defend oneself in a criminal matter are not deductible. For example, fees to mount a Racketeer Influenced and Corrupt Organizations (RICO) Act defense are not deductible even if an adverse determination results in forfeiture of property under the law. However, if the case arises in a business context, the fees may be deductible.
Wednesday, November 21, 2012
How To Compare After-Tax Bond Yields
When you are deciding whether to buy tax-exempt municipal bonds or taxable corporate bonds, your tax bracket will tell you whether the lower interest on tax-free bonds makes them a better investment. Here’s a simple way to help you make the right decision.
1. Divide the tax-free yield by the taxable yield.
2. Subtract the result from 100%. This will give you the tax bracket at which each of the investments will result in the same yield.
3. If you are in a higher tax bracket than the bracket you calculated in step two, the tax-free bond will give you a higher after-tax yield. If you are in a lower tax-bracket, the taxable bond will give you a better after-tax yield.
For example, assume that you are considering a tax-free bond that yields 6% and a taxable bond that yields 8%.
1. 6% divided by 8% equals 75%.
2. 100% less 75% equals 25%.
3. If your tax bracket is higher than 25%, the tax-free bond will give you a greater return. If your tax bracket is less than 25%, the taxable bond will give you a better return.
1. Divide the tax-free yield by the taxable yield.
2. Subtract the result from 100%. This will give you the tax bracket at which each of the investments will result in the same yield.
3. If you are in a higher tax bracket than the bracket you calculated in step two, the tax-free bond will give you a higher after-tax yield. If you are in a lower tax-bracket, the taxable bond will give you a better after-tax yield.
For example, assume that you are considering a tax-free bond that yields 6% and a taxable bond that yields 8%.
1. 6% divided by 8% equals 75%.
2. 100% less 75% equals 25%.
3. If your tax bracket is higher than 25%, the tax-free bond will give you a greater return. If your tax bracket is less than 25%, the taxable bond will give you a better return.
Tax Points
Succession planning loophole. Sell your business on an installment plan. This freezes the value at the current price. The seller reports capital gain on the installment basis, delaying taxes because gain is recognized only when and to the extent that installment payments are received. Interest must be added to the payments. The purchaser’s note will be included in the seller’s estate and the unpaid balance (the remaining portion of the capital gain), even though not yet received will be subject to income tax upon death.
Bonus depreciation. Under the law, businesses are entitled to claim 50% bonus depreciation for eligible new property placed in service in 2012. This means that half the cost of the property can be deducted in the first year, along with any additional depreciation on the other half of the property’s cost, as well as any first-year expensing.
Business use of personal cars. If you drive your personal car, truck or van for business, you can deduct the operating expenses related to business use. There are two ways to do this…Actual expense method. You can deduct your actual expenses related to business use of the vehicle – gasoline, oil, tires, repairs, insurance, etc. – plus an allowance for depreciation. Standard mileage rate. Deduct business driving in 2012 at the IRS rate of 55.5¢ per mile. This cents-per-mile allowance takes the place of actual expenses.
Bonus depreciation. Under the law, businesses are entitled to claim 50% bonus depreciation for eligible new property placed in service in 2012. This means that half the cost of the property can be deducted in the first year, along with any additional depreciation on the other half of the property’s cost, as well as any first-year expensing.
Business use of personal cars. If you drive your personal car, truck or van for business, you can deduct the operating expenses related to business use. There are two ways to do this…Actual expense method. You can deduct your actual expenses related to business use of the vehicle – gasoline, oil, tires, repairs, insurance, etc. – plus an allowance for depreciation. Standard mileage rate. Deduct business driving in 2012 at the IRS rate of 55.5¢ per mile. This cents-per-mile allowance takes the place of actual expenses.
Tax Tips
Credit card settlements
People with large credit card debt sometimes are able to settle for less than the full amount owed. If someone owes $25,000 and settles the debt in full for, say $8,000, the $17,000 difference is taxable income.
Loophole: This income is not recognized for tax purposes if the debt relief is part of a personal bankruptcy settlement or if the debtor is insolvent immediately before the debt cancellation.
Even in those situations, the lender will send a Form 1099-C, Cancellation of Debt, to the IRS reporting the cancellation of debt as income. To avoid tax, you must complete and attach Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to your tax return.
Long-term-disability insurance payments
Some employees who become disabled receive payment under an employer-provided disability policy.
These policies are often included in compensation packages as a tax-free fringe benefit. Other companies have cafeteria plans offering an array of benefits, including disability insurance, that employees must choose from. The tax treatment of these benefits depends entirely on who paid the premiums…
If the employer paid, benefits are taxable.
If the employee paid, benefits are tax free.
People with large credit card debt sometimes are able to settle for less than the full amount owed. If someone owes $25,000 and settles the debt in full for, say $8,000, the $17,000 difference is taxable income.
Loophole: This income is not recognized for tax purposes if the debt relief is part of a personal bankruptcy settlement or if the debtor is insolvent immediately before the debt cancellation.
Even in those situations, the lender will send a Form 1099-C, Cancellation of Debt, to the IRS reporting the cancellation of debt as income. To avoid tax, you must complete and attach Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to your tax return.
Long-term-disability insurance payments
Some employees who become disabled receive payment under an employer-provided disability policy.
These policies are often included in compensation packages as a tax-free fringe benefit. Other companies have cafeteria plans offering an array of benefits, including disability insurance, that employees must choose from. The tax treatment of these benefits depends entirely on who paid the premiums…
If the employer paid, benefits are taxable.
If the employee paid, benefits are tax free.
Tax Tip - Inherited Property
If you sell inherited property at a loss, you can deduct the loss on your tax return.
Example: Your parents leave you a house with an original purchase price of $100,000, and a market value of $300,000. You inherit the house estate tax free, receive a “stepped-up” basis of $300,000, and hold it as an investment (you do not live in it). When you sell the house for, say, $260,000, you
can deduct $40,000, subject to annual loss deduction limits. (As mentioned earlier capital losses are deductible dollar for dollar against capital gains and can offset up to $3,000 of ordinary income each year. Excess losses are carried forward to subsequent tax years.)
Added benefit: The loss is deductible even if it is created by brokerage commission payments.
Example: Your parents leave you a house with an original purchase price of $100,000, and a market value of $300,000. You inherit the house estate tax free, receive a “stepped-up” basis of $300,000, and hold it as an investment (you do not live in it). When you sell the house for, say, $260,000, you
can deduct $40,000, subject to annual loss deduction limits. (As mentioned earlier capital losses are deductible dollar for dollar against capital gains and can offset up to $3,000 of ordinary income each year. Excess losses are carried forward to subsequent tax years.)
Added benefit: The loss is deductible even if it is created by brokerage commission payments.
2012 Year End Tax Savers
College savings. Some states allow state income tax deductions for contributions to Section 529 college savings plans. If your state does, and you’re planning to send a child to college, consider making one.
Individual retirement accounts. Convert a traditional IRA to a Roth IRA to obtain future tax-free investment returns from the Roth IRA while escaping minimum annual distribution requirements. Added benefit: You can reconsider and reverse the conversion if you later decide it is not in your best interest or that you can make the conversion at a lower tax cost later if the value of your account had dropped – as late as October 15, 2013. You may reverse a conversion only once in a single year.
Capital losses. Take capital losses to end up with a $3,000 net loss for the year. A loss of up to that amount is deductible against ordinary income.
Individual retirement accounts. Convert a traditional IRA to a Roth IRA to obtain future tax-free investment returns from the Roth IRA while escaping minimum annual distribution requirements. Added benefit: You can reconsider and reverse the conversion if you later decide it is not in your best interest or that you can make the conversion at a lower tax cost later if the value of your account had dropped – as late as October 15, 2013. You may reverse a conversion only once in a single year.
Capital losses. Take capital losses to end up with a $3,000 net loss for the year. A loss of up to that amount is deductible against ordinary income.
Combined Payrolls Can Produce Tax Savings
It’s not unusual for closely-held corporations to operate through more than one division and for key employees to be on the payroll of both. If an employee’s combined salary from each corporation totals more than $110,100 excess Social Security taxes might be incurred.
There’s a way, however, to avoid this problem. Instead of each corporation issuing its own payroll check, designate one company in the group as a common paymaster, which can issue one check to the employee on behalf of all the companies involved. To do this, you must meet one of these three criteria:
• The corporations involved must have at least 50% common ownership.
• Half or more of the officers of one corporation must also be officers of another.
• The corporations must share at least 30% of their employees.
The result? Let’s say an employee is drawing a $100,000 annual salary from each of two corporations. Since the maximum Social Security tax is owed on the first $110,100 paid by each employer, the company will have to pay taxes on $200,000 in total. If a single check from the common paymaster company is issued, $89,900 of the total amount will be exempt from excess Social Security taxes.
There’s a way, however, to avoid this problem. Instead of each corporation issuing its own payroll check, designate one company in the group as a common paymaster, which can issue one check to the employee on behalf of all the companies involved. To do this, you must meet one of these three criteria:
• The corporations involved must have at least 50% common ownership.
• Half or more of the officers of one corporation must also be officers of another.
• The corporations must share at least 30% of their employees.
The result? Let’s say an employee is drawing a $100,000 annual salary from each of two corporations. Since the maximum Social Security tax is owed on the first $110,100 paid by each employer, the company will have to pay taxes on $200,000 in total. If a single check from the common paymaster company is issued, $89,900 of the total amount will be exempt from excess Social Security taxes.
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