As the End of 2009 Approaches, Now Is the Time to Evaluate Your Tax Situation

Jim Brandenburg, CPA, Shareholder - Tax   email | bio
November 2009

2009 held many changes to tax law. The most significant legislation was the American Recovery and Reinvestment Act of 2009 (ARRA). As this year draws to a close, now is the time to assess your personal and business tax situation. The list below offers some of the tax strategies and planning opportunities from this year’s legislation that may impact you, your family and your business.

Opportunities and Changes for Businesses and Their Owners

Bonus Depreciation for Federal Tax Purposes

One tax incentive Congress has enacted in hopes of stimulating economic growth is the bonus depreciation provision. Bonus depreciation applies to purchases of new qualified fixed assets in which businesses can take a 50 percent, up-front, tax deduction of the asset’s cost in the year the asset is placed into service. For more details on bonus depreciation and Section 179 expensing limits, please read the article “Give Your Business a Bonus” found this edition of The Adviser.

Last-in, First-out (LIFO) Inventory Still Available and Still Beneficial

Some industries have seen significant price increases in the past year. For instance, companies involved with certain metals have experienced a high rate of inflation. One way to lessen the impact of higher material costs is to reduce taxes using the LIFO inventory method. A high level of inflation generates higher cost of goods sold which translates into greater tax savings from LIFO. Inventory Price Index Computation (IPIC) is a particular LIFO method available for tax purposes that employs government price indices to determine the inflation of numerous products rather than using a company’s actual inflation. For instance, if the government’s pricing reports show 7 percent inflation but a company’s actual costs only increased 4 percent, the company can use the higher 7 percent inflation rate under IPIC. This can often generate sizable tax benefits. Below are three other items to keep in mind when considering LIFO. 

• First, the company can elect LIFO with the filing of its tax return. Therefore, a calendar year company can adopt the LIFO method with its 2009 tax return in March of 2010.
   
• Second, any company employing the LIFO method must also use the LIFO method on its financial statements and in turn will generally report lower book income.
   
• Third, Congress and the administration are considering eliminating the LIFO inventory method in the next few years. Several of the proposals would not only eliminate any LIFO benefits for future inflation, but all accumulated LIFO savings would be restored and spread into taxable income over a period of time. Nothing is finalized and there will likely be opposition to any LIFO repeal.

Tax Treatment of Prepaid Expenses and Other Intangible Costs

The IRS and taxpayers have long battled over the tax treatment of certain costs, especially costs paid to acquire prepaid assets or to create intangibles. Taxpayers attempt to deduct these costs in the year paid or to write-off these amounts as soon as possible. The IRS closely reviews the character and nature of these costs and often seeks to permanently capitalize these costs or to allow an amortization over an extended life of the expenditure. In order to reduce the disputes, the IRS provided guidance for taxpayers by developing a new 12-month rule. The 12-month rule indicates that taxpayers would not be required to capitalize amounts paid to create any benefit beyond the earlier of:

• 12 months after the first date the taxpayer realizes the benefit; or
   
• The end of the tax year following the tax year the payment is made.

As long as the payment does not provide any benefit that extends beyond the end of the following tax year, the prepaid cost would not need to be capitalized and could be deducted in the year paid. Finally, if a taxpayer opts to use this new method for deducting prepaid costs, it would be an automatic change of accounting method and would not require IRS approval or a separate filing fee.

Trademarks and the Like May Qualify for Tax-free Exchanges

A like-kind exchange is a popular way for a taxpayer to dispose of qualifying appreciated property without paying a current tax, and is often utilized with real estate sales. In a significant change from its prior policy, the IRS now says that certain intangible assets, such as trademarks and trade-names that can be valued separately and apart from goodwill, qualify as like-kind property that can be exchanged without incurring a current tax. Furthermore, the IRS says that except in rare and unusual situations, intangible assets such as trademarks, trade-names and customer-based intangibles can be separately described and valued apart from goodwill. It should be noted that there are several other requirements to qualify for a like-kind exchange.

New Wisconsin Tax Rules on Related Party Loans and Leases

Interest and lease expense deductions between related parties may be disallowed for 2008 Wisconsin tax purposes. This will have a wide-ranging application for many closely held businesses in Wisconsin. This new disallowance can be avoided with proper disclosures. Wisconsin has a new filing (Schedule RT) which must be filed for related party leases and loans for 2008, and more related party transactions and expenses will be covered beginning in 2009. These related party expenses must be reported and satisfy certain requirements to secure a deduction for Wisconsin tax purposes.

Opportunities and Changes for Individuals

Tax Rates

With individual tax rates expected to rise in the near future, you may want to consider the following:

• The maximum individual income tax rate will possibly rise to 40 percent or more in 2011 (or in 2010), and any discretionary income that can be moved into 2009 may be taxed at a lower rate.
• Taxpayers holding appreciated assets may want to consider generating capital gains and recognize the sale in 2009 to receive a 15 percent tax rate, rather than a 20 percent or more if they wait.
• Taxpayers involved in installment sales in 2009 (with some of the payments deferred into 2010 and after), should consider electing out of installment sale treatment by recognizing the entire gain in 2009.
• C Corporation dividends are taxed at 15 percent in 2009; however these rates may rise to 20 percent or more in 2010 or 2011. Companies planning to pay dividends may want to review the amount and pay these dividends prior to December 31, 2009.
• Individual rates may rise significantly in the near future, however, C Corporation tax rates will likely stay the same. Consequently, in some situations a company set up as an S Corporation may want to thoroughly evaluate a change to C Corporation status.

Clarifying guidance on Waivers of Required Minimum Distributions (RMDs) for 2009

Retirement plan account participants, IRA owners and their beneficiaries do not need to take their required minimum distributions for 2009 and the IRS has issued guidance clarifying this waiver. Individuals can still receive IRA distributions in 2009 if they prefer. Also, on a related matter, the next edition of The Adviser will address the 2010 opportunity for conversions into a Roth IRA account.

Obtaining the Maximum from the New Homebuyer’s Tax Credit

In two separate notices, the IRS explained how to take maximum advantage of the first-time homebuyer’s tax credit. The credit is calculated as the lesser of: 10 percent of the purchase price or $8,000 for a qualifying 2009 purchase ($7,500 for a qualifying 2008 purchase). The credit is refundable, meaning individuals will receive the credit even if they do not owe taxes. The tax credit must be repaid for a home purchased in 2008, but not for one purchased in 2009. A tax credit for a 2009 purchase can be claimed on the 2008 return. The IRS explained the different ways that individuals who recently purchased a home or are considering buying one in the next few months can claim the $8,000 credit for 2009 home purchases. In separate guidance, the IRS explained how unmarried co-owners can get the maximum credit amount. For more information on the extension and expansion of the is tax credit and the Workers, Homeownership, and Business Assistance Act of 2009, please read the “Timely Opportunity” in this edition of The Adviser.

New Guidance for Victims of Madoff-type Investment Schemes

The IRS issued comprehensive guidance for the investors caught in the Madoff and other similar Ponzi-style schemes. The guidance allows the losses to be claimed as theft losses against ordinary income and allows net operating losses to be treated as sole proprietorship losses eligible to be carried back three to five years. The guidance consists of a revenue ruling with specific tax issues that victims of Madoff-type schemes must confront and also a revenue procedure providing safe harbors for determining the proper time and amount of the deductible tax loss.

Good News for Claiming Motor Vehicle Sales Tax Deduction

For 2009, there is a new deduction for state and local sales and excise taxes paid on the purchase of new cars, light trucks, motor homes and motorcycles after February 16, 2009 and before January 1, 2010. The deduction is available whether you itemize deductions on Schedule A or claim the standard deduction. The deduction is limited to the tax on a purchase up to $49,500 for an eligible motor vehicle. The deduction can be on one or more qualifying purchases. The IRS has also announced that qualifying motor vehicle purchases made in states without sales tax, such as Alaska, Delaware, Hawaii, Montana, New Hampshire and Oregon, can also qualify for the deduction.

New Guidance on Life Settlements

Until recently, individuals who no longer needed a life insurance policy had few options available to them. They could surrender the policy to the issuing insurance company for its cash surrender value or they could stop paying the premiums and let the policy lapse. For a term insurance or other policy without cash surrender value the only option was to let the policy lapse. Now, for some individuals, there is a secondary insurance market in which the individual may be able to sell a policy for more than its cash surrender value or even sell a policy without cash surrender value. These transactions are referred to as life settlements. The IRS recently explained the tax consequences of life settlements. Anyone contemplating a life settlement can now gauge the tax impact of this transaction.

Estate Tax Changes Likely Before December 31, 2009

Congress will most likely make changes to the estate tax laws before the end of 2009. If not, the estate tax laws would expire in 2010, but would return in 2011 at the prior rate of 55 percent. Congress and the administration are intent on passing legislation this year to remedy this situation, although the specific change is still uncertain. Please watch for updates in upcoming issues of The Adviser.
 

Additional tax changes are likely in the coming year and perhaps even before 2009. Proper tax planning can afford sizable tax savings. If you have any questions, please contact Jim Brandenburg.