Tax & Business Strategies Monthly Newsletter - July 2008

Tax Planning Strategies
IRS Launches Summer Push to Reach Retirees and Disabled Veterans Who Have Yet to File for Their Economic Stimulus Payments

Business & Management Practices
New Credit for Small Business Employers That Pay Active Duty Differential Wages
IRS Bumps Mileage Rates for Last Half of Year

General Information
Raising Cash in Tough Times
Interest Rates Drop for the Third Quarter of 2008
Wonder What Your Odds of Being Audited Are?

Briefs
A New Twist for Your Favorite Game Show
Automobile Charitable Contributions Sharply Decline

Due Date Reminders
July 2008

TAX PLANNING STRATEGIES

IRS Launches Summer Push to Reach Retirees and Disabled Veterans Who Have Yet to File for Their Economic Stimulus Payments

Millions of retirees and disabled veterans qualify for the economic stimulus payment but have not filed to claim it. Statistics indicate about 74 percent in this group are accounted for in the stimulus payments currently being sent, leaving about 5.2 million potential recipients remaining. Later this summer, the agency will send them a special letter that explains stimulus payment eligibility and how to claim it.

The Economic Stimulus Act of 2008 generally provided for payments of $600 ($1,200 for married couples filing joint returns or the amount equal to the 2007 net income tax liability, whichever is less), plus $300 for each qualifying child. Payments also begin to phase out for individuals with adjusted gross incomes greater than $75,000 ($150,000 married couples filing jointly).

For people who have no tax liability or no tax filing requirement, there is a minimum payment of $300 ($600 for married couples), plus the $300 for each qualifying child. To be eligible for the minimum payment, individuals must have at least $3,000 in qualifying income. Qualifying income includes any combination of earned income, nontaxable combat pay and certain benefit payments from Social Security, Veterans Affairs and Railroad Retirement.

If you are one of those who have not yet filed for your rebate check, we can help. Give us a call as soon as possible.


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BUSINESS & MANAGEMENT PRACTICES

New Credit for Small Business Employers That Pay Active Duty Differential Wages

The recently-enacted Heroes Act creates a new tax credit for eligible small business employers that pay differential wages to qualifying employees who are performing service in the uniformed services while on active duty for a period of more than 30 days. The credit is equal to 20% of up to $20,000 of differential pay to each qualifying employee during the tax year, but only for payments after June 17, 2008 and before 2010.

A qualified employee is one who has been an employee for the 91-day period immediately proceeding the period for which any differential wage payment is made.

An eligible small business employer is one that:
(1) Employed on average less than 50 employees on business days during the tax year; and
(2) Under a written plan, provides eligible differential wage payments to each of its qualified employees.

Other Rules:

• Taxpayers under common control are aggregated when determining if a taxpayer is an eligible small business employer.

• The credit can't be claimed by a taxpayer that has failed to comply with the employment and reemployment rights of members of the uniformed services.

• No deduction may be taken for that part of compensation which is equal to the credit, and the amount of any other credit for compensation paid to an employee must be reduced by the differential wage payment credit allowed with respect to such employee.

• The differential wage payment credit is part of the general business credit and thus is subject to the rules for business credits.

• The credit is not allowable against a taxpayer's alternative minimum tax liability.

If you think you may qualify for this new credit and have questions on how it might affect your business, please give us a call.


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IRS Bumps Mileage Rates for Last Half of Year

The Internal Revenue Service recently announced an increase in the optional standard mileage rates for the final six months of 2008. Taxpayers may use the optional standard rates to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.

The rate will increase to 58.5 cents a mile for all business miles driven from July 1, 2008, through Dec. 31, 2008. This is an increase of 8 cents from the 50.5 cent rate in effect for the first six months of 2008.

In recognition of recent gasoline price increases, the IRS made this special adjustment for the final months of 2008. The IRS normally updates the mileage rates once a year in the fall for the next calendar year.

"Rising gas prices are having a major impact on individual Americans. Given the increase in prices, the IRS is adjusting the standard mileage rates to better reflect the real cost of operating an automobile," said IRS Commissioner Doug Shulman. "We want the reimbursement rate to be fair to taxpayers."

While gasoline is a significant factor in the mileage figure, other items enter into the calculation of mileage rates, such as depreciation and insurance and other fixed and variable costs.

The optional business standard mileage rate is used to compute the deductible costs of operating an automobile for business use in lieu of tracking actual costs. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.

The new six-month rate for computing deductible medical or moving expenses will also increase by 8 cents to 27 cents a mile, up from 19 cents for the first six months of 2008. The rate for providing services for charitable organizations is set by statute, not the IRS, and remains at 14 cents a mile.

Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

Mileage Rate Changes

Employers will also need to consider the impact on their employee reimbursements for business travel.

If you have any questions regarding this increase, please give us a call.


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GENERAL INFORMATION

Raising Cash in Tough Times

The ongoing housing and mortgage market mess, struggling stock market and uncertain economic climate means tough times for cash-strapped individuals who have to raise money for an immediate financial need. Compounding the misery is the fact that many people have locked away the lion's share of their savings in a tax-favored retirement vehicle, like a company profit-sharing or 401(k) plan, IRA, SEP, SIMPLE IRA, or Roth IRA. Getting to that money to solve a pressing financial crisis before age 59-1/2 isn't easy and can be financially painful.

Generally, tapping into a profit-sharing plan, IRA, SEP, or SIMPLE IRA requires a taxpayer to pay the tax on the amount withdrawn and, unless a taxpayer meets one of the limited exceptions, a 10% early withdrawal penalty. To make matters worse, where the taxpayer lives in a state with an income tax, and possibly a state early withdrawal penalty, the overall amount of the withdrawal that goes to taxes and penalties can approach 50% of the amount withdrawn. (Note: Roth IRAs and some Traditional IRAs include certain amounts that can be withdrawn without tax and penalty).

In general, there are only two ways for active employees who are under age 59-1/2 to tap their account balances in 401(k) plans: take a loan from the plan or take a hardship withdrawal, if they are eligible to do so. But just because the plan may permit a withdrawal for hardship, it does not mean that the withdrawal will avoid either being taxed or subject to the early withdrawal penalty.

401(k) Loans – When money is borrowed, there is no taxable event since it is merely a loan. However, loans must be paid back, and if a taxpayer subsequently defaults on a 401(k) loan, the loan becomes a taxable distribution subject to tax and penalties. An often-overlooked hazard to a 401(k) loan is the possibility of leaving employment with the plan’s sponsoring employer, at which time the loan would have to be paid in full or it would become a taxable distribution subject to the usual penalties.

Hardship Distributions – The law limits when distributions to participants of 401(k) and similar plans may be made – usually when the employee separates from service (retires, changes jobs), dies, becomes disabled or reaches age 59-1/2. For some plans, a hardship distribution may be permitted. A distribution is treated as made after an employee's hardship only if it is made on account of the hardship which, in turn, requires that the distribution be:

• Made on account of an immediate and heavy financial need of the employee; and
• Necessary to satisfy that financial need.

What is an immediate and heavy financial need? Under IRS safe harbor rules, a distribution is treated as made on account of an immediate and heavy financial need if made for:

(1) Expenses for (or necessary to obtain) deductible medical care (which includes expenses for the care of a spouse or dependent);

(2) Costs directly related to the purchase of a principal residence for the employee (excluding mortgage payments);

(3) Payment of tuition, related educational fees, and room and board expenses, for up to the next 12 months of post-secondary education for the employee, or the employee's spouse, children, or dependents;

(4) Payments necessary to prevent the employee's eviction from his principal residence, or foreclosure on the mortgage on that residence;

(5) Payments for burial or funeral expenses for the employee's deceased parent, spouse, children or dependents; or

(6) Expenses for the repair of damage to the employee's principal residence that would qualify for the casualty deduction.

Maximum distributable amount – A hardship distribution can't exceed the maximum distributable amount which includes the employee's total elective contributions on the distribution date, reduced by any previous distributions of elective contributions. It also may include employer contributions depending on how those contributions are made (i.e., matching or non-elective), and how the plan is organized. Not all plans are the same so the employer will need to be consulted.

Obtaining a hardship distribution from a 401(k) plan isn't easy, and shouldn't be used as a way to raise needed cash if other sources are available. The plan participant should keep in mind that:

• The taxpayer’s definition of hardship may not fit within the plan's definition.

• If the plan uses the safe harbor method of treating a distribution as necessary to meet an immediate and heavy financial need, he will be barred from making elective contributions (and will therefore forfeit any employer-matching contributions) for a period of at least six months.

• The taxpayer may have to take a loan first from the 401(k) plan before he can take a hardship distribution.

• Depending on how the plan is organized, the taxpayer may not be able to withdraw his entire balance.

• The taxpayer will forever lose the tax-deferred earnings buildup that would have accrued on the hardship withdrawal had it not been made.

• The taxpayer will have to pay tax at ordinary income rates on the withdrawal (assuming no after-tax contributions were made) and, probably, a 10% premature withdrawal tax as well.

Before tapping into your retirement funds, we encourage you to call this office so we can help minimize the damages and avoid penalties wherever possible. Using funds meant for your retirement can have long-term consequences that should be considered carefully.

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Interest Rates Drop for the Third Quarter of 2008

The Internal Revenue Service announced that interest rates for the calendar quarter, beginning July 1, 2008, will drop by one percentage point. The new rates will be:

• Five percent for overpayments (four percent in the case of a corporation);
• Five percent for underpayments;
• Seven percent for large corporate underpayments; and
• Two and one-half percent for the portion of a corporate overpayment exceeding $10,000.

Under the Internal Revenue Code, the rate of interest is determined on a quarterly basis. For taxpayers other than corporations, the overpayment and underpayment rate is the federal short-term rate plus 3 percentage points. Generally, in the case of a corporation, the underpayment rate is the federal short-term rate plus 3 percentage points and the overpayment rate is the federal short-term rate plus 2 percentage points. The rate for large corporate underpayments is the federal short-term rate plus 5 percentage points. The rate on the portion of a corporate overpayment of tax exceeding $10,000 for a taxable period is the federal short-term rate plus one-half of a percentage point.

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Wonder What Your Odds of Being Audited Are?

In recently-released data, the IRS released the audit statistics for return audit for the IRS fiscal year 2007. It provides information about how many returns are being audited and where the IRS is focusing their enforcement activities.

During fiscal year 2007, the IRS collected almost $2.4 trillion in taxes (net of refunds) and processed more than 235 million returns. More than 114 million individual income tax return filers received tax refunds that totaled $248.6 billion. In fiscal year 2007, IRS spent an average of 40 cents to collect each $100 of tax revenue, which was the lowest in seven years and down from 42 cents per $100 in fiscal year 2006.

So what are your chances of being audited? A total of 1,384,563 individual income tax returns were audited out of a total of 134.5 million individual returns that were filed in the previous year. This is about 1.0% of all individual returns filed, up slightly from the previous year. Only 22.49% of the audits were conducted by revenue agents, tax compliance officers, and tax examiners; the bulk of the audits (about 77.5%) were correspondence audits. These percentages are about the same as they were in the prior year. The IRS is pretty good at selecting which returns to audit, since approximately 85% of the audits result in the taxpayer owing additional taxes.

What issues are the audits focusing on? Here is a roundup of selected audit rates:

o Earned Income Credit (EIC) - Of the total number of returns audited, 503,267 (36.5%) were selected on the basis of an earned income tax credit (EITC) claim.

o Schedule F (Individual Farm Returns) - About 1.5 million individual returns included farm returns. Of this group, only 5,705 (0.4%) were audited.

Individual returns can include additional business related schedules that can increase the odds of audit. Among those are Schedule C (non-farm sole proprietorship), Schedule E (supplemental income and loss from rentals, partnerships and S-corporations), or Form 2106 (employee business expenses). The following statistics apply to non-EIC returns including these schedules:

o Individual Returns without a Schedule C, E, F, 2106 – 4%
o Individual Returns with a Schedule E or 2106 – 1.2%
o Individual Returns with a Schedule C – These are categorized by size of gross receipts reported on the return.

- Under $25,000 – 1.3%
- $25,000 to $100,000 – 2%
- $100,000 to $200,000 – 6.2%
- $200,000 or more – 1,9%

The IRS also focuses their audit levels on higher-income returns as evidenced by the following statistics based on total positive income (TPI):

o Non-business Returns with a TPI of at least $200,000 and under $1 million – 2%
o Business returns with a TPI of at least $200,000 and under $1 million – 2.9%
o All returns with TPI of $1 million or more – 9.3%

For returns other than individual returns, the audit rates by type were:

o Estate and trust income tax returns - 0.1%
o Corporations with less than $10 million of assets - 0.9%
o Corporations with $10 million or more of assets - 16.8%
o S corporations - 0.5%
o Partnerships - 0.4%
o Estate tax returns - 7.7%
o Gift tax returns - 0.6%

In fiscal year 2007, IRS assessed 27.3 million civil penalties against individual taxpayers of which 55% were for failure to pay and 28.2% for underpayment of estimated tax. There were also 327,822 assessments for accuracy and negligence penalties.

The IRS is also becoming less likely to settle tax disputes with taxpayers who, for hardship reasons, offer to pay less than the amount due in order to settle up with the IRS. In 2007, 46,000 offers in compromise were received by IRS, and only 12,000 (26%) were accepted.

On the corporation side, there were a total of 762,718 civil penalty assessments (up from 701,785 for FY 2006), 82.9% for either failure to pay or underpayment of estimated tax.

Because of the IRS’s high success rate for their audit programs, it is probably not wise for a taxpayer to represent themselves during an audit. This is best left to those of us who understand the audit process and can address potential issues that arise. So, if you receive an audit notice, the next call you make should be to this office.

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BRIEFS

A New Twist for Your Favorite Game Show

We all have our favorite game shows such as Wheel of Fortune, The Price is Right, or Deal or No Deal, and we love to have the contestants win big. Often, the game show host will ask the contestants what they would do with the money. The response is usually to go on vacation or buy a house or car.

We seldom, if ever, hear anything about giving the government part of the winnings. But after all the celebrating is over, the game show will issue the winning contestant a 1099 for the amount of the cash and fair market value of the prizes won, which is taxable on the contestant’s state and federal tax returns.

If a contestant wins cash, they just need to set aside enough of the cash winnings to pay their taxes. The amount of the tax will vary by individual, based on their tax bracket and the state they live in. The federal tax can be as high as 35% and some states as high as 10%. Most individuals who are contestants on these programs are probably in the 15 to 25% federal tax brackets and 2 to 5% state. Thus, on average, the tax on the winnings will be around 22%.

But what happens to the contestant that wins a prize? They will be taxed on the fair market value of the prize, which is usually the full retail value. The winner ends up having to dig into their pockets to come up with the cash to pay the taxes. And, if the contestant wins something they have no use for, they are still stuck with the taxes unless they refuse the prize or contribute the prize to charity.

Let’s talk about the individual with limited means that wins an $80,000 vehicle. It might cost them well over $17,500 (which they probably don’t have) just to pay the income taxes on the prize, not to mention the problems it creates for their parents who usually claim them as a dependent.

Thinking about the taxes involved with winning a prize can add a new twist to watching your favorite game show. Please call our office if you find yourself in this situation.

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Automobile Charitable Contributions Sharply Decline

The IRS maintains very detailed statistics regarding various items included on tax returns. These statistics are generally released two years behind. In a recent bulletin, the IRS provided statistics relating the drop in the number of individuals claiming a deduction for donating their car to charity, as well as a substantial drop in the values claimed for the vehicles.

Congress believed that charitable contributions were being abused and has made several law changes in an effort to curtail the abuse. For 2005, a significant change was made to the deduction amount allowable for vehicle donations. In previous years, taxpayers could deduct the fair market value of the automobile. Starting in 2005, the deductible amount for most donated vehicles was changed to the lesser of the fair market value or the gross proceeds from the sale of the vehicle by the charity.

The effects of this tax law change are clearly reflected in the data.

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DUE DATE REMINDERS

July 2008

July 1 - Time to Review Your 2008 Year-to-Date Income and Expenses

Time to review your 2008 year-to-date income and expenses to ensure estimated tax payments and withholding are adequate to avoid underpayment penalties.

July 10 – Report Tips to Employer

If you are an employee who works for tips and received more than $20 in tips during June, you are required to report them to your employer on IRS Form 4070 no later than July 10. Your employer is required to withhold FICA taxes and income tax withholding for these tips from your regular wages. If your regular wages are insufficient to cover the FICA and tax withholding, the employer will report the amount of the uncollected withholding in box 12 of your W-2 for the year. You will be required to pay the uncollected withholding when your return for the year is filed.

July 15 - Social Security, Medicare and Withheld Income Tax

If the monthly deposit rule applies, deposit the tax for payments in June.

July 15 - Nonpayroll Withholding

If the monthly deposit rule applies, deposit the tax for payments in June.

July 31 – Self-Employed Individuals with Pension Plans

If you have a pension or profit-sharing plan, you need to file a Form 5500 or 5500-EZ for calendar year 2007.

July 31 – Social Security, Medicare and Withheld Income Tax

File Form 941 for the second quarter of 2008. Deposit or pay any undeposited tax under the accuracy of deposit rules. If your tax liability is less than 2,500, you can pay it in full with a timely filed return. If you deposited the tax for the quarter in full and on time, you have until August 11 to file the return.

July 31 – Certain Small Employers

Deposit any undeposited tax if your tax liability is $2,500 or more for 2008 but less than $2,500 for the second quarter.

July 31 – Federal Unemployment Tax

Deposit the tax owed through June if more than $500.

July 31 – All Employers

If you maintain an employee benefit plan, such as a pension, profit-sharing, or stock bonus plan, file Form 5500 or 5500-EZ for calendar year 2007. If you use a fiscal year as your plan year, file the form by the last day of the seventh month after the plan year ends.

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