Clackamas
Income Tax & Accounting Inc.

Save Money on your Taxes

Tax saving tips and tricks for individuals and businesses

The following brochures are available to help you make smart tax and financial decisions. Just call or email us and we'll gladly send you any of the following brochures free of charge:

• Tax Guide for the Self-Employed
• 15 Ideas for Cutting Your Business Taxes
• 17 ideas for Improving Your Business Profits
• Improving Cash Flow in Your Business
• Deducting Travel, Meals, and Entertainment Expenses
• How to Use Financial Information in Your Business
• Tax Guide for Rental Real Estate
• Tax Guide for Homeowners
• Education Tax Breaks
• Capital Gains Taxes
• IRS Audits
• How to Keep More of What You Make

Choose one of the links below to see online brochures and other important information:

1. HAVE AN OFFICE IN HOME? NEW IRS RULES - BEWARE!
   
   
2. BUSINESS SUCCESSION PLANNING FOR THE FAMILY-OWNED BUSINESSES
   
   
3. A REALLY SIMPLE RETIREMENT PLAN
   
   
4. TIPS FOR TAX-EFFICIENT INVESTING
   
   

HAVE An Office IN HOME? NEW IRS Rules - Beware!

The Taxpayer's Relief Act of 1997 (TRA '97) allows a wider range of businesses to use the office-in-home deduction. But, you will be in for an unpleasant surprise unless you fully understand this new tax law and how it will later affect the sale of your home.

Up through December 31, 1998, you could take the office-in-home deduction only if the use of your home office meets these strict rules:

• It must be the principle place of business unless it is a separate structure;
• The home office portion must be used exclusively for business; and
• It must be a place used to meet with patients, clients or customers. This third rule eliminates the office-in-home deduction for most businesses that do administrative work at home but perform most of the work outside of the home.

The new, more lenient law, which takes effect January 1, 1999, allows the deduction when:

• The office is used by the taxpayer to conduct administrative or management activities; and
• There is no other fixed location of the business where the taxpayer conducts these activities.

If you qualify for a home office, you may deduct a portion of the expenses of running your home including rent or mortgage, taxes, insurance, security systems, repairs, utilities, depreciation, etc.

If you rent your home, and qualify, you should take the office-in-home deduction. You have nothing to lose and often get a substantial business deduction.

If you own your home, the law states the home office deduction must decrease the basis of your home by the amount of depreciation on the building, regardless of whether or not you actually take a depreciation deduction.

If you are doing business during the year you sell your home and you realize a gain, you must report the sale of the business portion of your home as a capital gain -- you cannot include the business portion of the sale in the capital gain exclusion ($250,000). If you go out of business the year before you sell you can avoid paying tax on the business portion of the sale and include it in the capital gain exclusion. But, any depreciation that you claimed or could have claimed after May 6, 1997, is taxable when you sell your home, whether or not you are still running a business. So, beginning May 7, 1997, if you are a homeowner and you take an office-in-home deduction you will no longer be able to take the full capital gain exclusion when you sell.

However, it may still be to your benefit to take the office-in-home deduction by weighing it against the benefits of the capital gain exclusion, taking into account such factors as purchase price, length of time you expect to own the home, appreciation, personal tax rates, etc.

BUSINESS SUCCESSION PLANNING FOR THE FAMILY-OWNED BUSINESSES

  For many people, the family business interest is the most valuable asset owned by the family, representing a considerable financial and emotional investment. Their wealth and dreams are tied directly to the performance of their family-owned business. The issues business owners face are especially complicated because business goals and family needs are interwoven, and sometimes in direct opposition. But the rewards of building and continuing a family tradition can far outweigh the difficulties.

One of the greatest challenges for any founding owner is ensuring that the business continues when the founder steps out of the picture. Developing a succession plan long before it is needed is the best way to accomplish this goal. Unfortunately, the majority of family business owners jeopardize the future of their business and their family's wealth because they don't plan adequately in this area.

Although most founding owners dream of passing the business to one of their children, a successor needs more than the family genes. Objective answers to these and other questions can give you an indication whether your child is right for the job.

• Do you share common business goals?
• Is your child an entrepreneur, a risk taker?
• Do you respect your child's management ability?
• Does your child have a solid understanding of the business?
• Will your child earn the support and respect of the employees, creditors and customers?

If there are several children in the family, but only one is appropriate as a business successor, this causes additional concerns. The estate distribution must still be fair, without causing the business management problems caused by minority shareholders. For example, non-management shareholders want to maximize (taxable) dividends while management shareholders want to maximize not-taxable compensation and accumulate capital for expansion.

Transferring the responsibility to a successor can be a traumatic experience for any business owner. It can lead to serious conflicts between family members. Starting the process early, giving your successor adequate training and setting a firm retirement date can smooth the transition.

If none of your children has all of the skills needed to run the business, you'll need to look for an outsider. One of your present managers or a group of employees may be a suitable buyer. Your company's business advisors can also help locate and evaluate an outside buyer.

Determining the value of your business requires professional assistance, but in general the value reflects the business' ability to generate income in the future. Maximizing the value of the business is sometimes important, for example, when putting it up for sale. When the goal is reducing gift and estate taxes, a lower value is better. To keep the value low, consider splitting the ownership among the family so no one person has a controlling interest. Various courts have ruled that the value of minority interests may be as much as 30% less than controlling ones. Your financial and tax advisor can perform the initial step - a business valuation analysis. With this figure, you can recognize the issues and the approximate dimension of the problems. Should you then wish to sell the business, you will want to consider a full appraisal by a qualified firm.

A REALLY " SIMPLE" RETIREMENT PLAN

 Until now, businesses with 25-100 employees haven't enjoyed a good tax-saving retirement plan. SEP and SAR-SEP qualified retirement plans are great for businesses with 1-25 employees and the 401(k) plan has worked for businesses with 100 or more.

A new plan called SIMPLE (Savings Incentive Match Plan for Employees) combines the best features of the SEP and 401(k) plans and offers employee benefits for the 25-100 employee based business as follows:

Two types of SIMPLE: (1) individual IRA for each employee or (2) 401(k) type with savings kept in collective trust. All contributions are 100% vested at all times for both types.

UP-SIDE:

• No annual reporting by the employer -- the custodian files necessary IRS forms.
• The self-employed (business owner) is eligible to participate.
• Employees earning $5000 in the prior year are eligible.
• Employees may defer (before taxation) up to $6000 annually through salary deductions (which is slightly less than the $9500 maximum allowed under SAR-SEPs or 401(k)s).
• SAR-SEPs and 401(k)s require complex calculations at year-end to prevent discrimination in favor of higher-compensated employees. This is not required under the SIMPLE plan.

CONSIDERATIONS:

• Although removal of complex calculations makes the plan more attractive, there is a consideration. Under SIMPLE, employers contribute dollar-for-dollar of the employee's contribution up to 3% of the employee's salary. Or, the employer may contribute a flat 2% for all eligible employees. In a "down year" the contribution may drop to 1% any 2 out of 5 years. The maximum employer-matched contribution for a SIMPLE IRA is $6000 and for a SIMPLE 401(k) it is $4500.
• Also, a SIMPLE IRA early withdrawal (before 59-1/2 years of age) has a 25% penalty if removed before 2 years' participation in the plan. Any other withdrawal after 2-years' time and before age 59-1/2 pays a 10% penalty.

BEST ADVICE: Get your financial planner or accountant to run the numbers for your situation -- a profit sharing plan with 401(k) features or a SEP plan may still be the better plan for you.

Plan Types: SIMPLE IRA vs. SIMPLE 401(k)

Tips For Tax-Efficient Investing

When evaluating the performance of your investments, don't overlook the impact taxes have on your total return. It is important to always consider the tax implications of your investment decisions.

#1 - New tax laws favor long-term investing.

In 1997 congress passed new tax legislation changing the holding periods and rates that apply to short- and long-term capital gains.

• Short-Term Capital Gains ( securities held for 12 months or less ) - are taxed at the individual's ordinary income tax rate.
• Long-Term Capital Gains ( securities held for more than 12 months ) ' are taxed at 10% or 20% (depending on the individual's tax bracket.

#2 - Before selling an investment, understand the tax implications.

If you need to sell, sell shares you've held for more than 12 months and you'll qualify for the lower capital gains rates.

If you're planning on selling shares of mutual funds or stocks, you can actually control the amount of gain or loss you report. Your profit or loss is the difference between your cost basis (what you paid for the shares, plus expenses and reinvested distributions) and the sales price. Therefore, if you bought shares at different times, some will have a higher cost basis than others.

You can specify which shares you want to sell. By redeeming shares with a higher cost basis, you'll pay a smaller taxable gain. However, if you want to take a gain because you have losses to offset, you may want to sell the shares with the lowest cost basis. Of course, you must keep thorough records of how much you paid for your shares.

#3 - Manage your gains as well as your losses.

If you're considering selling some of your funds, you may want to sell underperforming funds in order to offset some of your realized gains. You can take up to $3,000 of loss each year against your ordinary income. Any capital loss over $3,000 will be carried over to future years.

It may also make sense to sell a fund that has lost value before it makes its year-end distribution. This way, you may take the tax loss and avoid the income tax liability on the distribution.

#4 - Turnover rate can be an important factor in a fund's tax-efficiency.

If the turnover rate within a fund (frequency at which a fund manager buys and sells securities) is high, it usually results in a high capital gain distribution to shareholders of the fund. Funds that utilize a buy-and-hold strategy can reduce a fund's turnover, which potentially means lower taxable distributions to the shareholders. Index funds and other tax managed funds with a lower turnover ratio (outside a tax-deferred account) may help investors increase their after-tax returns.

#5 - Beware of a fund's annual distribution.

If you're thinking about investing in a fund at year end, it may make sense to wait until after its annual distribution has been paid.

Funds must distribute substantially all of their income, capital gains and dividends at year end. You would be taxed on the payout, but the value of your investment would not have increased. You might consider purchasing shares after the record date to avoid an unnecessary tax bill.

#6 - Take taxes into consideration when purchasing bond funds.

Municipal bonds potentially can offer higher after-tax yields than comparable taxable investments for individuals in higher tax brackets. It is important to compare actual yields.

Tax Equivalent Yield = Municipal Yield/1-Federal Income Tax Rate

For example, if you are in the 31% Federal Tax Bracket: 7.25% = 5.00%/1-.31

As you can see tax-exempt Muni bonds paying 5.00% are equivalent to taxable bonds paying 7.25%.

You may also benefit by purchasing municipal bonds issued by the taxpayer's state and avoid state taxes.

#7 - Take advantage of tax-deferred investment vehicles.

Maximize your contributions and take advantage of any matching contributions provided by your employer. You'll reduce your current taxable income as well as defer taxes on your investments.

#8 - Pay attention to the type of investments you put in tax-deferred and taxable accounts.

You generally should consider placing your high yield investments such as high-yield corporate bonds or equity funds with higher turnover in your tax-deferred accounts. Conversely, your more tax-efficient investments such as index funds and equity funds with a buy-and-hold strategy should be held in your taxable accounts.

#9 - Beware of the Alternative Minimum Tax (AMT).

Although it was designed to make the wealthy pay their fair share of taxes, many middle-income taxpayers are becoming subject to AMT.

People most likely to be subject to AMT if one or more of the following applies:

• Incomes over $75,000 and some large itemized deductions
• Several children
• Interest deductions from second mortgages
• Interest from specified tax-exempt private activity bonds
• High state and local taxes
• Realized gains on inventive stock options

Investors who are subject to AMT, or close to it, should monitor how much of their tax'exempt interest is subject to AMT. You tax advisor can provide you with more information about AMT.

Consider a Roth IRA.

Unlike a traditional IRA, Roth IRAs allow you to take distributions on a tax-free basis if the account has been open for at least five years, and if distributions are made in any one of these cases:

After the account holder reaches age 59-1/2

Death or disability of the account holder

First-time home purchase expenses (maximum $10,000 lifetime limit)

Request More Information from Clackamas Income Tax