Tax Tips Blog

Doug would like to know:My mom wants to transfer some her stock to me as a gift (generous mom ). There is a 43% capital gains increase since she purchased the shares. If she transferred the stock directly to me, who pays the tax on the capital gains? Should I have her sell the stock and just give me the proceeds?

My reply: Thanks for visiting Doug!

If your mother gives you her stock, then her basis in the stock (whatever that is) and her holding period (whatever that is) becomes your basis and holding period in the stock, and you pay the tax on the capital gains whenever you sell it. If your mother sells the stock, she will pays the capital gains tax on the sale. Then she can give you the net proceeds and it has no affect on your taxes. You should take into consideration a couple of other things:

1. Your tax bracket vs. your mother’s tax bracket
2. The value of the stock

You and your mother may be in different tax brackets. If one of you happens to be in the 15% or below tax bracket, then that person would pay long term capital gains at a 5% rate vs. 15% for others. If your mother is gifting you stock or cash worth more than $12,000, then she is going to have to file a gift tax return. Most likely she will not have to pay any tax on this (unless she has already gifted millions of dollars in the past), but she will still have to file the gift tax return. You will have no reporting or tax paying obligations from this gift. If this is the case then you should also consider splitting the gift between 2006 and 2007. For example, if the stock is worth $15,000, she could give you $12,000 worth of the stock in 2006 and the other $3,000 worth of stock in 2007 and not have to file a gift tax return. On another note, if your mother decides to will you the stock, then your basis would be the fair market value of the stock on the date of her death.

Tony asks: I paid $500 to an investment adviser and bought securities that should yield me about $4,800 in tax exempt interest and $1,200 in taxable interest. Do I get to deduct the amount I paid to the investment adviser? My response:Hello Tony! Expenses that are allocable to tax-exempt income are not deductible. You should try to ask your investment adviser to break out the fee between recommendation for tax-exempt interest and taxable interest. If he is unwilling or unable to do so, then you are allowed to allocate the expense between the two. In your situation you have a total of $6,000 of interest ($4,800 + $1,200) of which 20% is taxable interest ($1,200/$6,000). Therefore, using this allocation method you should be able to deduct $100 of his $500 fee as an investment expense. It should be noted that several tax professionals use other allocation methods which may yield a higher deductible amount. You should discuss this possibility with your tax professional.

Elizabeth purchased 500 shares of stock on November 18, 2005 for $5 per share, giving her a basis of $2,500. The stock is now trading at $30 per share (potential selling price of $15,000). Elizabeth wants to realize her profit because she’s afraid it will decline in value, but she is concerned about her taxes because selling before November 18th will result in a short-term capital gain and Elizabeth is in the 33% tax bracket. Elizabeth can use the following formula to determine what price is the “break-even price” or the price at which selling the stock as a short-term capital gain at 33% tax rate would equal the same net amount of cash as if she sold the stock as a long-term capital gain at 15% tax rate: Breakeven point = (Current Price - [(Current price - basis) X ordinary tax rate] - .15(basis)/.85) Putting Elizabeth’s numbers into this equation we have: Breakeven point = ($30 - {($30-$5)X .33] - .15($5)/.85) Elizabeth’s breakeven point = $26.47 If Elizabeth were to sell her stock at its current price, her after-tax proceeds would be $10,875. If the price of her stock were to fall to $24.71 after November 18th, her after-tax proceeds would be $10,875. Thus, if Elizabeth believes that her stock price will not fall below $24.71 per share between now and November 19, 2006 should would net more after-tax money by holding her stock until at least November 19, 2006 when her sale would be treated as a long-term capital gain.

Joseph from Springfield, MO asks:

I understand that for 2006 & 2007, a person can take their RMD from their IRA, have it sent directly to a charity (church) and not have to report that amount as income on Fm 1040.  The receiving charity would have to provide verification the gift was indeed received.  Do you have any information on how the gift is handled, i.e., can it in fact be done?  Is there a special code used on the 1099 to advise Internal Revenue that this transaction is different from the ordinary RMD distribution or is some other form completed to attach to the 1040?  Your comments will be appreciated.
Joseph

My response:
Hello Joseph!  Thank you for visiting my blog.

President Bush did sign legislation that allows IRA owners who are 70-1/2 or older, who are required to make minimum distributions, donate those distributions directly to charity.  There are certain rules that must be followed, one of which is that the trustee must send the withdrawal directly to the charity.  These distributions will count against your required minimum distributions for the year and it is excluded from your income.  When you receive your 1099 from your trustee (the person who made the withdrawal and sent it directly to a qualified charity), they will indicate the “Gross Distribution” in Box 1 and the “Taxable Amount” in Box 2a.  They will indicate, with the appropriate distribution code, in box 7 that the withdrawal was made via a trustee transfer directly to a qualified charity.  Since there are other requirements that must be met it is best to have your tax accountant discuss this with your trustee to make sure the transaction is carried out appropriately.

I hope this answers you question.

Best wishes,
Gina

Follow-Up:
Ms Gwozdz,
Thank you for the prompt and informative reply to my question.  I have
asked for information from the IRS 800 number somewhere.  The local
office folks hadn’t even heard about the matter.  Local tax preparers had
no information, only suppositions.  One CPS I talked with at least knew
about the rule but would not have any definitive information until he
attended a meeting in December to get updated on tax changes. 

Its very hard to tax plan if you don’t know the rules.  Now its possible
to take some action.

Thanks again for the information.

Joseph

Trisha has owned her home for over 20 years. She originally purchased her home for $100,000 and there is not currently a loan on the home. Her home is estimated to be worth $300,000. Trisha wants to move closer to her only grandchild and needs the cash from her current home in order to put money down on her new home. Trisha has strong ties to this area and hopes to move back here in a few years, so she doesn’t want to sell her home. Trisha is thinking of renting her current home instead of selling it. If Trisha simply converts her home to a rental property the property’s basis would be the lower of cost or market value, and in her case this would be $100,000. Trisha should consider forming a wholly owned S corporation and having the S corporation purchase the home from her at fair market value, with the help of a bank loan. Trish should contribute enough cash to the S corporation to make the minimum down payment that would be required by a bank. This way, Trisha would receive $300,000 from the sale of her home to her S corporation (and net $240,000 if she contributed $60,000 to her S corporation), and the $200,000 gain on the sale of her principal home ($300,000 fair market value sales price less $100,000 original purchase price) is excluded from tax (sale of her primary residence). Therefore, this transaction is accomplished at no tax cost. This money could now be used as a down payment of a home near her grandchild. The S corporation can now rent the house and take depreciation deductions on the stepped up fair market value of $300,000 cost allocated to the house (the portion allocated to the land is not depreciable). If the S corporation is able to rent the house in excess of the cash outlay for mortgage payments, insurance, taxes and operating costs, this could provide Trisha some continued cash flow and possible tax benefits associated with residential rental properties. Any gain or loss from the rental activity would be passed through to Trisha, subject to the passive activity rules. If the house was subsequently sold by the S corporation for a gain, the gain would be taxed at capital gains rates (15%) and possibly some depreciation recapture at 25%. However, if she is only going to be gone a couple of years, the gain, will most likely not be that large, due to the step up in basis.

The most tedious and dreaded part of running a small business for most owners is maintaining their accounting records. The IRS requires every business owner to maintain accurate records so that they can determine if you have properly reported all your income and expenses. If your small business was ever audited you would have to prove every deduction your business claimed. The only way to do this is by showing them your receipts for every business expense.I have found that the easiest way for new businesses to do this is to have a folder that corresponds to each tax item on their return. For example, if you are a sole proprietor your file folders would probably include:

• Income Your Business Received

• Returns and Refunds
• Inventory purchased for resale
• Advertising
• Car and Truck Expenses
• Commissions and Fees
• Contract Labor
• Employee Benefits
• Insurance
• Interest
• Legal and Professional Services
• Office Expense
• Pension and Profit Sharing Plans
• Rent
• Repairs and Maintenance
• Supplies
• Taxes & Licenses
• Travel
• Meals & Entertainment
• Utilities
• Wages
• Other Expenses
• Business Use of Your Home
• Business assets used more than one year
• Cash – Bank Accounts
• Credit Cards
• Loans

Many businesses use software programs to help them add up all their receipts. This is perfectly acceptable, but you still need to maintain the original receipts and having them in separate file folders will make them much easier to find in the future.

Usually the IRS has 3 years to audit your company, but under certain situations, they can audit you as far as 6 years back. For this reason it is probably wise to keep all receipts for at least 6 years. Receipts that are related to assets that are used in your business for more than one year, such as buildings, equipment, furniture, etc. should be kept until 3-6 years after you sell or otherwise dispose of the item.

Our population is aging and with that comes the time when our parents can no longer care for themselves. When this happens one of three things usually occurs:

• they hire someone to come in to their home to care for them;
• they move into a care facility; or
• they move into your home and you provide their care.

If they stay in their own home and hire in-home care, the portion of the care that is directly related to their medical care is deductible as a medical deduction, even if the person they hire is not a nurse. If the person they hire is also providing household services, the amount paid to this person should be divided between the medical care and household care. The person they hire for in-home care is considered a household employee and they would be responsible for the tax requirements of being their employer. If they decide to move into a care facility (like a nursing home) and the primary reason they moved into that facility was to receive medical care, then the cost of the care, including meals and lodging is all deductible as a medical deduction. If they move in with you, there are some tax benefits that can relieve some of the financial burden associated with being a caregiver. These benefits include a change in your filing status, a possible exemption for them, medical expense deductions, a dependent care credit and possible exclusion of payments under a life insurance contract. If you aren’t married, and your parent is living with you and you are providing more than half of their household costs, you may qualify for “head of household” status, which provides a more favorable tax rate structure than “single” status. There are several rules to determine if you are allowed to claim them as your dependent, but the main ones include you providing more than half of their support costs, them not having gross income in excess of $3,300 for 2006 and them either being a U.S. citizen or a resident of the U.S., Canada or Mexico. If they do qualify as your dependent or if they fail as your dependent only because they do not meet the gross income test, then you can include any medical expenses you pay for them as a medical deduction on your tax return. If you hire someone to care for them in your home, the amounts attributable to medical care are deductible for you as a medical deduction. Anything they do that is not consider medical care is not deductible. As I indicated above, this person is considered a household employee and you would be responsible as their employer. If they qualify as your dependent, and they are not able to take care of themselves, you may qualify for the dependent care credit. This credit is for costs that you incur for someone to care for them, so that you and your spouse can go to work. If they happen to be either terminally or chronically ill, then any lifetime payments received under a life insurance contract on their life can be excluded from gross income. These rules can be beneficial and complicated, so when you are faced with these issues, it is best to discuss this situation with your tax professional to make sure that you are taking advantage of every tax break available.

When you own a small business and the owners have loans to or from themselves and the company it is very important that the company properly document the loan(s) so the IRS doesn’t come back and reclassify them (as either a distribution, salary, capital, dividend, etc.).

Write up a promissory note to help substantiate that the transaction was in fact a loan. You do not need an attorney to do this, but you should probably use either software or a sample promissory note purchased from a local office supply store to make sure all pertinent information is included in the note. Pay special attention to the following:

• Unconditional promise to pay (This means you can’t say that they only have to pay if they win the lottery or you only have to pay if your sales increase by 300%)

• The date the money is due or that it’s due on demand

• State what the interest rate will be or how it can be determined. Loans, by their nature charge interest. If you do not charge interest then the IRS will either not view it as a loan or assume the interest was “gifted” (imputed interest)

• When payments must be made

Beware that even with doing the above, the IRS may still reclassify your loan for various reasons. For example, the IRS may not view the transaction as a loan if the borrower was not “credit worthy” and the loan was not secured.

If you’re a first time homebuyer in Texas and your maximum household income level is at 100% (for a family of 1-2 persons) or 115% (for a family of 3 or more persons) of the median family income for the area of Texas in which the home you wish to buy is located, then you may be eligible for a credit against your mortgage interest. The Texas Department of Housing and Community Affairs created a Mortgage Credit Certificate (MCC) Program for residents of the state of Texas. The amount of the annual tax credit is 35% of your annual mortgage interest up to $2,000 per year each year that you own your home and use it as your principal residence. Even though the credit cannot be larger than your Federal income tax liability, you can carry the excess forward up to 3 years. If you sell this house for a gain, within the first 9 years you own it and your income, at the time of the sale exceeds certain limits, you may have to recapture some of the benefit you previously received. If you believe you may be eligible for this credit or have to pay a recapture tax due to this credit, you should seek the help of a tax professional as this can get a bit complicated. To learn more about this program you can read the program information packet (PDF) or visit the Housing Administrator, Inc. website at http://housingadministrators.com/texasmcc/.

It is very common that employees sometimes pay for business expenses out of their own funds, instead of the company’s funds. When this happens the employee wants to be reimbursed for this money and the company usually complies. How these reimbursements are treated for tax purposes depends on whether or not your company has an accountable plan. An accountable plan is a written reimbursement arrangement with these three requirements:

1. The reimbursements that the company makes must be made to the company’s employee for expenses that the employee paid that are expenses your company is allowed to deduct for business purposes.
2. Your employee must be required to substantiate the amount, time, use, and business purpose of the reimbursed expenses to the company. The easiest way to accomplish this is to require your employees to submit expenses reports and attach their receipts to that report.
3. Your employee must be required to return to the company any excess of reimbursements over substantiated expenses within a reasonable period of time. I advise my clients to have their employees reimburse their employer within 90 days, but the IRS has allowed as long as 120 days after the expense was paid or incurred.

If you have an accountable plan then your company can write a check for the reimbursement amount to your employee and deduct the expenses as if your company paid for them directly. If you do not have an accountable plan (also know as have an “unaccountable plan”) and you reimburse your employees for these expenses then you must add the reimbursement to your employee’s wages and withholding income taxes and employment taxes on these amounts. Therefore, if you have an accountable plan you will be saving your company the employer portion of Social Security and Medicare taxes. In addition your employee will not have to pay taxes on these amounts or deduct them on their own return. Having an accountable plan may seem like a hassle or a lot of paperwork, but it could save you a lot of tax dollars.