The interest from savings bonds you cash in may be tax-free. That can be the case if you use the money for college tuition and fees.- Several conditions apply. For example, you must have been at least age 24 when you bought th bonds.
- Either you or your spouse must own the savings bonds.
- The bond proceeds may be used for the owner’s education, the owner’s spouse’s education, or the education of a dependent for whom the owner claims an income tax exemption.
- Income limits exist for this tax benefit. For completely tax-free income, your modified adjusted gross income (MAGI) in 2011 must be no more than $106,650 on a joint tax return or $71,100 on other returns. The tax exclusion is completely phased out with MAGI of $136,650 on joint returns and $86,100 on other returns. These numbers increase with inflation.
2011 Q3 | Use Appreciated Assets for Charitable Donations
Writing a check is the easiest way to make charitable contributions. However, donating appreciated assets can be more tax-efficient. That’s true if the donated assets have been held longer than one year and, thus, would qualify for long-term capital gains tax treatment on a sale.
Example: Mark Parker wants to donate $5,000 to a local animal shelter. If he writes a check for $5,000, he’ll get a $5,000 tax deduction. Mark’s cost for this deduction is $5,000, after-tax.
Instead, Mark goes through his portfolio and finds a stock he bought in 2009 for $3,000 and, thus, would qualify for long-term capital gains treatment. That stock now sells for $5,000. Mark decides to donate the stock to the animal shelter. With this approach, Mark gives a donation of $5,000, the fair market value of the donated assets. However, those shares are really not worth $5,000 to Mark. To cash them in, he would owe tax on a $2,000 long-term capital gain. At a 15% tax rate, Mark would owe $300. Therefore, by donating the shares, Mark gets a $5,000 tax deduction by relinquishing an asset that would be worth only $4,700 to him, after-tax.
After the contribution, the animal shelter can sell the donated shares.
As a charitable organization, the shelter owes no tax on the sale. Consequently, the chairity gets the same $5,000 contribution with this strategy, and Mark is better off than he would have been writing a check.
To implement this strategy, you can call the charity and get its brokerage account number. Then, call your own broker or mutual fund company and explain what you want to do and provide the charity’s account number. If you wish to donate part of a position, specify the shares you wish to contribute. Follow up by sending an e-mail to your broker or fund company and eventually check with the charity to confirm the transaction.
Note: Different rules apply to contributions of tangible personal property, patents and other intellectual property, and property contributed to certain private foundations. In most cases, the deduction for a property in one of these categories will be limited to the property’s fair market value less the long-term capital gain that would have been recognized if the property had been sold for fair market value at the time of contribution.
Spreading the wealth
The procedure described in the previous paragraph can work well if you are making one or two relatively large charitable contributions. However, if you plan to make $500 contributions to each of 20 charities, the process may get cumbersome. Instead, consider donating through a donor-advised fund (DAF).
Many financial firms and local community foundations offer a DAF. You make donations directly to the fund; the minimum initial contribution might be a lump sum donation of $10,000. You’d get a charitable deduction for the year the assets go into the DAF. If you donate appreciated assets held longer than one year, your deduction usually will be the assets’ fair market value.
The DAF typically will create an account in your name after it has received your initial contribution. Then, the DAF will sell the donated assets, owe no tax, and put the cash into your account. Subsequently, you can request the DAF to make “grants” to specified charities from your account. For multiple donations of appreciated securities, using a DAF will simplify the process.
2011 Q3 | State Taxes Can Crimp Your Cash Flow
If your company does business solely in one state, it probably owes tax to that state, as well as to the federal government. Many companies, however, operate across state lines, and therefore, may owe tax to more than one state. In the current economic slowdown, some states are endeavoring to address tax shortfalls by aggressively seeking more tax from companies based in other states.
Types of tax
State taxes come in several categories. The most common include
• income taxes. If your company has net income from operations within a state, that state may tax those profits.
• sales taxes. These taxes generally are imposed on the retail sale of goods (that is, when goods are sold to an end user). The buyer usually pays this tax, but the seller is ultimately responsible for collecting the tax and remitting the money to the state.
• use taxes. Buyers who avoid sales tax on a purchase will generally owe a use tax on it. A use tax is a tax on the storage, use, or consumption of tangible personal property within a state. In some states, use taxes also apply to purchases of certain services. Use taxes are complementary to sales taxes; if a taxpayer pays sales tax on an item or service, it will be exempt from use tax.
• For example, suppose a company based in Maine purchases goods from a supplier located in Massachusetts and uses the goods in Maine. If the company in Maine does not pay a sales tax, it will owe a use tax. Use tax rates are the same as sales tax rates.
• other taxes. States sometimes also employ a variety of other taxes in addition to or in place of the taxes discussed previously. These include franchise taxes, which are taxes imposed for the privilege of doing business in that state, and taxes on a taxpayer’s gross receipts.
Complex connections
Even if your company has some out-of-state activity, it may not owe any or all of these taxes to every state in which it operates. Generally, your company’s tax obligation will depend on whether its activities in a given state are sufficient to create nexus. This term describes a connection to a state that reaches a level justifying taxation. If a company has nexus with a state with regards to a particular type of tax, it will be subject to that tax in that state.
Although the principle of nexus is easy to understand, determining when a business has nexus with a state for a specific type of tax can sometimes be anything but easy. Within broad parameters prescribed by the U.S. Constitution and certain federal laws, each state can set its own nexus standards, and these standards can vary widely from state to state. Also, within the same state, the standards for nexus for one type of tax can be significantly different than for another type of tax. In addition, because the ways that companies do business are constantly changing (for example, selling through the Internet and employing telecommuters), and the states are constantly seeking to expand the boundaries of nexus in order to increase their potential tax base, the rules in this area are seldom stable. Activities or situations that, in the recent past, may not have been a source of nexus with a particular state may now or in the future result in a company’s being taxed by the state.
The bottom line is that states differ in what they consider nexus, and the rules in the area are continuously evolving. Due to the very serious repercussions that having nexus with a state can cause, many cases challenging a state’s assertion of nexus have come before different states’ courts, with varying outcomes. Before you expand your operations beyond your home state, check the nexus laws of the new states in which you are planning to do business and decide whether the business opportunities justify the potential tax cost. Our office can help you learn about the nexus rules in states your company has targeted for business.
2011 Q3 | Voluntary Disclosure for State Taxes
Companies may discover that they had nexus in a given state and, thus, owe back taxes.- Most states allow voluntary disclosure agreements (VDAs). These agreements call for the company to submit delinquent tax returns and pay the required taxes.
- Typically, a VDA will limit the lookback period to three or four years. No penalties will be assessed if the company pays taxes in full for those years.
Managing Tax Records
The IRS posted five tips on keeping good tax records, including: (1) the use of a three-year rule for keeping most records, (2) certain records that should be kept longer (e.g., settlement statements, stock transactions, IRA and business and rental property transactions), (3) general advice on keeping documents that impact the federal tax return, and (4) the kinds ofrecords that should be kept (e.g.,r receipts, invoices, mileage logs). IRS Pub. 552 (Recordkeeping for Individuals) contains additional information what kinds of records to keep. IRS Tax Tip 2011-71.
2011 Q2 | Income Tax Rates Hold Steady
Tax legislation passed at the end of 2010—the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of2010—maintains the person in effect since 2003. In 2011 and 2012, those rates range from 10% to 35%. In 2012, we might see yet another debate on future tax rates.
Capital gains and dividends
The 2011 and 2012 tax rates ranging from 10% to 35% are on ordinary income: earnings, interest on savings accounts, pensions, and so on. For long-term capital gains and qualified dividend income (which includes most dividends received by investors), the top tax rate remains at 15% for this year and the next. Therefore, investors are likely to continue to seek dividend-paying stocks and all types of investments that may eventually produce long-term gains, such as stocks and real estate.
What’s more, the tax rate on long-term gains and qualified dividends remains at 0% for taxpayers in the 10% and 15% tax brackets. In 2011, those brackets apply to single individuals with taxable income up to $34,500 and to married couples filing joint tax returns with taxable income up to $69,000.
Consequently, some tax strategies remain effective. Suppose a retired couple projects they will have $50,000 of taxa e Income In t IS couple holds appreciated securities, they could take as much as $19,000 of their long term capital gains and owe 0% in tax on those gains.
In addition, individual investors now can exclude from tax 100% of any gains from investments in certain small business stock. This tax exclusion had been 50% until a law passed in 2009 increased it to 75%, and a law passed in 2010 created a 100% tax exclusion. Under the new tax law, investors may qualify for a 100% tax exclusion on gains from certain small business stock acquired after September 27, 2010, and before January I, 2012.
Other income tax benefits
Beyond tax rates, the new law extends many income tax benefits that were scheduled to end after 2010. For example, all taxpayers will be able to fully use their itemized deductions and personal exemptions in 2011 and 2012. If the new law had not been passed, certain high~ income taxpayers would have lost some of those tax breaks. Similarly, some tax credits that had been scheduled to end or lose value are still available in 2011 and 2012 at 2010 levels. These include the earned income credit, the child tax credit, the dependent care credit, the adoption credit, and the American Opportunity Tax Credit for higher education. The research tax credit, which expired at the end of 2009, was reinstated retroactively for 2010 and remains in effect for 2011.
Coverdell Education Savings Accounts still have a $2,000 annual contribution limit, not the $500 cap that would have returned. Some individual tax provisions were reinstated retroactively, so they apply to 2010, as well as 2011. This list includes optional deductions for state and local sales taxes, higher education tuition deductions, teachers’ deductions for classroom expenses, IRA charitable rollovers for taxpayers age 70 1/2 and older, and enhanced tax advantages for some donations of conservation easements.
Addressing the alternative minimum tax
The new law also includes another “patch” for the alternative minimum tax (AMT). Every year or two, a patch has increased the AMT exemption amount and allows nonrefundable personal credits to offset both regular tax and AMT liability. Here are the new AMT exemption amounts:
Singles and heads of households:
2010 – $47,450 | 2011 – $48,450
Married persons filing jointly:
2010 – $72,450 | 2011 – $74,450
Married persons filing separately:
2010 – $36,225 | 2011 – $37,225
If Congress had not addressed the AMT issue, the AMT exemption amounts would have been $45,000 for joint filers; $33,750 for singles and heads of households; and $22,500 for married persons filing separately. As a result of the new law, fewer taxpayers will be subject to the AMT.
Payroll tax holiday
Although the new tax law generally does not change income taxes from 2010, it does provide a significant break in payroll taxes. During 2011, employees will contribute 4.2% of compensation for Social Security instead of the normal 6.2%. In 2011, employees pay Social Security tax on the first $106,800 of earned income. Thus, taxpayers who earn at least $106,800 in 2011 will save $2,136 in payroll tax: 2% of $106,800. Self-employed individuals will enjoy similar tax savings.
Employers will continue to pay 6.2% of an employee’s earnings, up to $106,800. Under current law, the employees’ share of Social Security tax will go back to 6.2% in 2012.