Monthly Archives: May 2016

Here’s My Article About Prince and the Estate Tax

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prince estate tax

The estate tax is still around, but it is as good as dead for the vast majority of people.  When I began practicing in tax in 1996, anyone who had a gross estate over $600,000 had to be concerned about the estate tax. This $600,000 amount was the estate tax exemption amount for that year.  The gross estate for U.S. citizens and permanent residents includes assets held throughout the world, the face amount of life insurance, and various other items that may surprise taxpayers.

I Would Die 4 U and File a 706 Return

While the estate tax is applied to asset transfers upon his or her death, the gift tax applies to transfers made during life.  This prevents people from gifting all their assets shortly before death to avoid the estate tax.

The estate tax exemption amount for 2016 is $5.45 million, and is indexed for inflation.  Anyone with a gross estate under $5.45 million will not have to file an estate tax return or pay the estate tax.  While anyone with a gross estate over $5.45 million will have to file an estate tax return, there may not be a tax due because the gross assets are reduced by liabilities, estate tax deductions, and the exemption amount.  These items may reduce the taxable estate to nothing.  The estate tax rate is currently 40%.  Besides the estate tax exemption, another significant deduction is the marital deduction.  Basically, the first spouse to die could transfer his or her assets to the surviving spouse after death and receive a deduction from estate tax.  The problem with this strategy is that It wasted the first deceased spouse’s exemption amount.

Example:  John and Joan are married.  For this example, the estate tax exemption amount is $1 million.  Each of them has $1 million in assets.  If all of John’s assets are transferred to Joan upon his death, he would owe no estate tax because his $1 million gross estate is reduced to $0 by the marital deduction.  The problem is that Joan now has $2 million in assets.  When she dies, her gross estate is $2 million.  The $2 million gross estate is reduced by her $1 million estate tax exemption leaving her with a $1 million taxable estate.  If the estate tax rate is 40%, her estate tax would be $400,000. 

Nothing Compares to Portability

Portability refers to the new ability of one spouse to transfer her unused estate tax exemption to her surviving spouse.  Before portability, each spouse had an exemption amount and the exemption amount could not be transferred to the surviving spouse.  A common tax planning technique was to create two trusts upon the death of the first spouse.  The first trust would basically be funded with an amount equal to the exemption amount.  This is the family trust which could be used to support the surviving spouse and the other family members.  The amount used to fund the family trust would be sheltered by the estate tax exemption amount.  The remainder of the assets would either be transferred directly to the surviving spouse or to a marital trust which would only support the surviving spouse.  The amount used to fund the marital transfer would be sheltered by the marital deduction.

Example: Ricky and Lucy each have assets of $1.5 million and the estate tax exemption amount is still $1 million.  Upon Lucy’s death, she transfers $1 million of assets to a family trust that can provide support to Ricky and other family members.  Lucy is thus able to utilize her estate tax exemption amount.  The remaining $500,000 of her assets will be transferred directly to Ricky.  Lucy’s $1.5 million estate is thus reduced to $0 by her $1 million exemption amount (the amount transferred to the family trust) and by the $500,000 marital deduction for the transfer to her spouse.  Ricky’s gross assets are $2 million (his own $1.5 million plus the $500,000 he inherited, but not the $1 million in the family trust).  Ricky can now employ additional estate tax reduction techniques to get his taxable estate.  Without this strategy, Ricky would have $3 million of gross assets (his and Lucy’s $1.5 million in assets) and would have to do more extensive planning to reduce his taxable estate by an additional $1 million.   

Let’s Pretend We’re Married/Elect Portability

Under portability, the use of the family trust is no longer needed solely to utilize the estate tax exemption amount.  The first spouse to die can transfer his unused estate tax exemption amount to the surviving spouse.  This is done by electing portability on a timely filed estate tax return.  If the only reason for filing the estate tax return is to elect portability, a simplified return can be filed.

Example:  Fred and Wilma each have assets of $5.45 million.  The 2016 estate tax exemption amount is $5.45 million.  Fred dies and leaves all of his assets to Wilma.  Fred’s executor files an estate tax return and claims a $5.45 million marital deduction for the transfer to Wilma.  Fred’s executor also makes a portability election to transfer Fred’s unused $5.45 million estate tax exemption to Wilma.  Wilma now has $10.9 million in assets.  If Wilma dies shortly after, her gross estate of $10.9 million is reduced by her own $5.45 million estate tax exemption and her spouse’s unused estate tax exemption of $5.45 million.

Needless to say, the examples in this post were over-simplified but the purpose was to show the basic mechanics of the estate tax system.  While the need for estate tax planning has been diminished, the need for estate planning for succession, asset protection, business continuity and many other issues is still very, very important.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

How Long Should Tax Records be Kept?

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tax recordsBusinesses must maintain tax records to substantiate amounts reported on their tax returns.  Because of the hustle and bustle of business ownership, many business owners consider record keeping a low priority.

Bad Things Happen When Records Are Not Kept

However, if the IRS audits a business and the business owner has failed to maintain adequate records, the result can be catastrophic.  Imagine spending $20,000 on marketing and failing to keep records of this expense.  If the IRS disallows the deduction, and the taxpayer is in the 25% tax bracket, the IRS will send a bill for $5,000 plus significant penalties and interest.  Imagine if the business owner had $200,000 in expenses and didn’t keep adequate records.

The IRS Requires Records to be Kept

Every taxpayer is required by IRC Section 6001 to maintain adequate tax records and to make those records available to the IRS upon request.  When determining how long to keep tax records, we typically look at the relevant statute of limitations periods—the period of time a taxpayer can amend a tax return to claim a credit or refund or for the IRS to assess additional tax.  The statute of limitations begins running from the tax return’s original due date (generally April 15th), or the date filed, if later.

The statute of limitations is generally 3 years.  However, the limitations period is 6 years if the tax return understates gross income by more than 25%.  There is no statute of limitations if a tax return was never filed or a fraudulent return was filed. There are special statutes of limitations for certain types of deductions (e.g., a 7 year statute of limitations applies to bad debts and worthless securities).

How Long Should Records be Kept?

A good rule of thumb is to add one year to the statute of limitations period.  You often hear tax records should be kept for 7 years.  This is based on the 6 year statute of limitations for returns that have a greater than 25% understatement of income, plus one year.

Certain tax records, however, should be kept much longer than described above and, in some cases, indefinitely.  Records substantiating the purchase price of property that could eventually be sold, such as investment property and business assets, should be retained based on the record retention period for the year the property is sold.

Keep in mind that there may be nontax reasons to hold on to records beyond the time needed for tax purposes.  This might include documents such as insurance policies, leases, real estate closing statements, employment records, and other legal documents.

The 7 year retention policy for tax purposes is a good rule of thumb (unless a special statute of limitations applies).  The State of Michigan has a 4 year statute of limitations, in general.  The 7 year retention policy will thus work well in the State of Michigan.

Records Can be Scanned into Computer Files

It’s also important to know that the IRS allows taxpayers to store certain tax documents electronically.  The rules permit taxpayers to convert paper documents to electronic files (e.g., pdf or image files) and maintain only the electronic files.  Then, the paper documents can be destroyed.  Certain requirements must be met to take advantage of the electronic filing system, so contact us if you have any questions.

To see how this applies to you, give us a call at 248-538-5331.

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Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

When are Work Clothes Deductible?

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Personal Expenses Generally Not Deductibleclothing deduction

Personal expenses are not deductible.  However, the Internal Revenue Code allows a deduction for all ordinary and necessary expenses incurred while carrying on a trade or business.  A trade or business includes the trade or business of being an employee—meaning unreimbursed expenses of an employee are deductible as an itemized deduction subject to the extent they exceed 2% of adjusted gross income.

Expenses for purchasing and maintaining clothing are generally nondeductible personal expenses even though the clothing may be worn by a taxpayer in connection with his or her trade or business.

But…

Clothing expenses may be deductible if:

  • The clothing is required or essential in the taxpayer’s employment or business
  • The clothing is not suitable for general or personal wear
  • The clothing is not actually worn outside the taxpayer’s trade or business

All three requirements must be met for the clothing to be deductible.  Whether the clothing is suitable for general or personal wear is an objective test—meaning a reasonable person would not wear the clothing outside of her trade or business (the taxpayer’s personal belief about whether the clothing is suitable for personal wear is irrelevant.)

The third requirement basically means that even if the clothing is not suitable for general wear, if the employee actually wears the clothing in his personal life, the clothing expenses are not deductible.

Examples

Example:  In a recent Tax Court case, a sales person for Ralph Lauren was required to wear Ralph Lauren clothing in his job.  The sales person attempted to deduct the cost of this designer clothing, but the deduction was disallowed.  Even though he was required to wear the Ralph Lauren clothing, the clothing was suitable for general/personal wear, so the deduction was disallowed.

Example:  John is an attorney who purchases expensive suits to impress potential clients.  Again, because the expensive suits are suitable for personal wear, the suits are not deductible.

Example:  Terry is a flight attendant.  Since his flight attendant uniform is not suitable for general wear, the cost of his uniform is deductible.

Example: Tina works at a fast food shop and is required to buy her uniforms.  Again, since these uniforms are not suitable for personal wear, the uniforms are deductible.

Example:  Same as example 3 except that Tina actually wears her uniform to social functions.  Since she wears the uniform personally, the uniforms are no longer deductible.

To see how this applies to you, give us a call at 248-538-5331.

freeconsultation

Buzzkill Disclaimer:  This post contains general tax information that may or may not apply in your specific tax situation. Please consult a tax professional before relying on any information contained in this post.

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