Washington Watch

     We now have a definite proposal for $792 billion in tax cuts which appears headed for a veto.  The impetus behind the GOP push for tax relief is well articulated by Senator Phil Gramm.  A recent speech by Senator Gramm states that we have a projected surplus of $3 trillion (with a “T”) over the next ten years, so it seems only fair to give back less than a third of this amount over the same period of time.  Others have pointed out that, of the $3 trillion surplus, almost $2 trillion comes from Social Security and Medicare payments and projected increases in the rates of those taxes.  Since no one is willing to cut Social Security or Medicare benefits, two thirds of the $3 trillion is already allocated. If that’s true, instead of returning  33% to the taxpayers, the proposed tax cuts would be returning 80% to them.  Other opponents point out that all of the projections are based upon a booming economy.  As home mortgage interest rates pass the 8% mark for the first time in years, many wonder how long it can continue. 

     President Clinton is backing a more modest $250 billion package of tax cuts with the promise of more cuts later if the economy continues.  There is a much higher likelihood that a compromise will be reached.  The question is will it be reached before the end of the year or not?  If not, taxpayers may be in for a surprise.  For 1998 child credits and several other tax credits were excluded from the Alternative Minimum Tax (AMT).  That exemption expired on December 31, 1998 however.  Unless some extension is enacted,  there may be a surprise waiting for taxpayers in the form of AMT tax liability.

     It is pretty clear that there needs to be some major overhaul with respect to the inequalities of some parts of our tax structure.  The marriage penalty is an obvious place to start.  There is no reason for penalizing those taxpayers who choose to marry over those who are single.  Estate taxes also need to be simplified and dramatically reduced.  A general repeal of estate taxes has virtually no chance of passing.  Expanding the deduction for health insurance is also a great idea whose time has come.  Republicans want to allow a deduction without an income limitation.  The Democrats are pushing for a 30% tax credit. Other areas needing major work are the dreaded Alternative Minimum Tax referenced above, additional education incentives, and streamlining rules for retirement plans. 

     One item that has a very slim chance of passing is the proposed reduction of the capital gains tax rate to 15% and dropping all tax brackets by 1%.  The first generally is accepted as only benefiting top income earners, and the second would be incredibly costly.  Here’s why.  For 1996, everyone earning over $74,986 was in the top 10% of all taxpayers.  While that is not in the Bill Gates level, it is probably a much lower figure than you would have guessed.  That means 90% of the country made less than $75,000 for 1996.  Now you see why reducing the capital gains tax rate is going to be hard.  90% of the voters probably won’t get much benefit.  Those in the 15% bracket are only paying 10% for capital gains already.  Further, reducing tax brackets by 1% costs the government about a gazillion dollars in taxes, and doesn’t push any social or fiscal agenda.  Good luck on that proposal.

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Distribution  From Traditional IRAs

     Although advance planning is needed to help accumulate the biggest possible nest egg in your traditional IRAs (including SEP-IRAs and SIMPLE-IRAs), it is even more critical that you get help in planning for distributions from these tax-deferred retirement planning vehicles. There are three areas where knowing the ins and outs of the IRA distribution rules can make a big difference in how much you and your family will keep after taxes:

(1) Early distributions. If you need to take money out of a traditional IRA before age 59-1/2, e.g., for education expenses for children, to help make a down payment on a new home, or to meet necessary living expenses if you retire early, any distribution to you will be fully taxable (unless nondeductible contributions were made, in which case part of each payout will be tax-free), and also may be subject to a 10% penalty tax. There are several ways that the penalty tax (but not the regular income tax) can be avoided, including a method that is tailor-made for individuals who retire early and need to draw cash from their traditional IRAs to supplement other income.

(2) Naming beneficiaries. The decision of whom to designate as beneficiary of your traditional IRA is critically important. It determines the minimum amounts you must withdraw from the IRA when you reach age 70-1/2, who will get what remains in the account at your death, and how that IRA balance can be paid out. What's more, a periodic review of whom you've named as IRA beneficiaries is vital to assure that your overall estate planning objectives will be achieved in light of changes in the performance of your IRAs, and in your personal, financial and family situation.

(3) Required distributions. Once you attain age 70-1/2, distributions must commence from your traditional IRAs. At least a minimum amount must be withdrawn each year or you risk a 50% penalty on what should have been paid out but wasn't. In planning for these required distributions, your income needs must be weighed against the desirable goal of keeping the tax shelter of the IRA going for as long as possible for both yourself and your beneficiaries.

If it seems that it's easier to put money in a traditional IRA than to take it out, you're absolutely right. This is one area where expert guidance is an absolute must, and where we can be of particular help to you and your family. Call us for an appointment to review your traditional IRAs, and to analyze other aspects of your retirement planning.

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To Roth or Not to Roth

     The downside of converting a traditional IRA to a Roth IRA is that you have to pay income taxes on all previously untaxed amounts.  Because of the gyrating stock market, some people have been playing games with their IRA investments—converting from traditional to Roth, undoing the conversion, then reconverting to a Roth when the market drops in an effort to arrive at the lowest possible tax bill.

          Example.  When Judy’s IRA was worth $100,000, she converted it to a Roth IRA.  Uncertain of her decision, she had the Roth IRA recharacterized as a traditional IRA.  Later in 1998, her IRA was worth just $75,000 because her stock investments had lost value.  At that point, Judy decided to reconvert to a Roth IRA.  Because Judy was allowed to undo her previous conversion and then reconvert to a Roth when the value of her account was lower, she saved herself income taxes on $25,000.

     Now the IRS has decided to put some limits on the number of times individuals can reconvert.  In general, you are allowed just one reconversion in 1999.  But the rules are tricky.  Call us for details and assistance.  

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By-passing 401(k) Plan Testing

     Employers with 401 (k) plans are required to compare the average contribution rates of highly compensated and nonhighly compensated employees every year.  The idea behind the testing is that the plan should benefit everyone, not just top earners.

     Nondiscrimination testing complicates plan administration and often results in highly compensated employees not being able to contribute fully to the plan.  As a result, some employers are deciding to adopt new safe harbor plans that eliminate the need for testing.  With a safe harbor 401 (k) plan, the employer must:

(1) Contribute a minimum of 3% of compensation for every eligible nonhighly compensated employee (whether or not the employee contributes anything to the plan) or:

(2) Match nonhighly compensated employees’ elective deferrals 100% up to 3% of compensation plus 50% for the next 2% of pay deferred.

     Other requirements may apply.  But don’t guess – call us and let us help you with the details.

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When Your Vehicle Lease Ends

     You may be hit with some charges you weren’t expecting if you don’t buy the vehicle.  Items to look for in your lease agreement include:

Charge for excess wear.
The dealer may charge you for body damage, worn tires, or other “unusual” wear and tear.  Your agreement should contain the standards for excess wear.

Charge for excess mileage.
You may have to pay for extra miles you drive over the mileage allowance outlined in your contract.

Disposition fee.
This fee covers the dealer’s cost of selling the car.

Termination charge.
If you end your lease early, you may have to pay an extra amount.  Usually, the charge will vary with the amount of time left in the lease term.

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Deducting Expenses When Starting a New Business

     Generally an ongoing business deducts its allowable ordinary and necessary operating expenses as they are incurred or it capitalizes the expenses of buying or creating long-lived assets. The cost of long-lived assets is then deducted, depending on the nature of the asset, over a number of years by either depreciation or amortization write-offs.

     Relative ease in deducting expenditures  is not always the case. When a new business is started, or an existing business is significantly expanded, costs that might ordinarily be deducted in an established venture may instead have to be capitalized. These "start-up" expenses may in some instances then be deductible over a period of five years or more, if the taxpayer properly elects to amortize the start-up costs on the first return filed after the start-up period has ended.

     This section of the tax code can be a tremendous trap for the unwary. First, the definition of start-up expenses is any amount paid or incurred in connection with (1) investigating the creation or acquisition of a business, (2) creating a business, (3) engaging in any activity that "prepares" for the opening day of a new business. Specific categories of expenses such as interest, taxes, and research and experimentation expenses are excepted from this rule.

     The problem that many taxpayers face is if they fail to recognize a start-up expense in time, and if the IRS subsequently disallows a claimed deduction, the expenses can not be written off until the business is either sold or liquidated. Clearly this can be a substantial risk for many taxpayers.

     The start-up rules are very general in nature and their applicability has to be determined on the basis of facts and circumstances of each case. Once it has been determined that a new business start-up has occurred, the second issue that frequently comes into question is when has a business actually "begun " since the treatment of many costs changes once the doors are opened.

     Examples of investigatory costs that are common to many start-up businesses include consulting services and surveys to analyze and evaluate potential markets, products,  labor supplies, transportation facilities, regional taxation issues, regional legal environments, labor union penetration, and overall economic conditions for a prospective venture. This category of expenses includes the salaries, travel, and other costs of owners, executives, and managers as they participate in the investigation process.

     Examples of start-up costs after a decision is made to establish a particular business include executive time, effort, and expenses in creating the business, pre-opening advertising costs, recruiting and training costs for new employees, travel and other expenses in lining up suppliers, customers, and distributors, operating expenses such as rent, utilities, insurance, and repairs that are incurred prior to the "opening" date.

     If you are the owner of a new business, or if you are considering starting a new business, and you have any questions about whether start-up costs are being incurred, or what to do if they are, please contact our firm to give you guidance through the maze of rules and regulations that you will facing in ensuring the deductibility of your expenses.    

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