Why is this Topic Important to Wealth Managers? This topic presents discussion on the child and dependent care credit. For those wealth managers who participate fully in clients planning decisions, it is helpful to understand the implication of tax credits generally. This particular blogticle explores one such credit, the child and dependent care credit.

In addition this blogticle presents an excerpted preview of new, updated material from Advanced Markets which will be available soon (see www.advisorfx.com). Over the coming 9 months, the entire AUS service is being revised and will be rolling out monthly. The updating will include many new areas and a sharper focus with practical explanations and client presentation aides for current areas. We look forward to helping you secure your next sale.

A credit is available for certain child and dependent care expenses incurred by a taxpayer as a result of employment.[1] Eligible taxpayers are allowed a credit of up to 35% of certain expenses incurred for the care of a “qualifying individual.” [2] However, the credit is subject to several restrictions.

First, the 35% is reduced (but not below 20%) by one percentage point for each $2,000 (or fraction thereof) by which the taxpayer’s adjusted gross income for the taxable year exceeds $15,000.[3] The effect of this reduction is that for taxpayers with adjusted gross income of more than $43,000 the applicable percentage is 20%.

A second restriction further reduces the credit by limiting the amount of expenses eligible for the credit to $3,000 for one qualifying individual or $6,000 for two or more qualifying individuals.[4]

A “qualifying individual” is defined as: (1) a child under age 13 for whom the taxpayer is entitled to take a dependency exemption, (2) a physically or mentally incapacitated dependent, or (3) a physically or mentally incapacitated spouse.[5]

Expenses for household and dependent care services are “employment related” if they are incurred to enable the taxpayer to be gainfully employed.[6] “Gainful employment” includes periods in which the taxpayer is employed full-time, part-time, or in active search of gainful employment.[7]

Expenses for services outside the taxpayer’s household qualify only if they are in respect to a child under age 13 or a qualifying individual who regularly spends at least eight hours each day in the taxpayer’s household.[8] However, no amount of any expenses for overnight camp will be considered “employment-related.” [9]

Payments for child or dependent care to a close relative qualify for the credit so long as: (1) neither the taxpayer nor his spouse is entitled to claim the relative as a dependent; and (2) the relative is not a child of the taxpayer who is younger than age 19 at the close of the taxable year. Taxpayers must provide the name, address and taxpayer identification number of the child care provider in order to claim the credit.[10]

The full material presented under this section will be available soon. Check back with Advanced Markets for more information. Tomorrow’s blogticle will continue to discuss important planning aspects of 2011.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

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[1] IRC Sec. 21(a)(1).

[2] IRC Sec. 21(a)(2).

[3] IRC Sec. 21(a)(2).

[4] IRC Sec. 21(c).

[5] IRC Sec. 21(b)(1).

[6] IRC Section 21(b)(2).

[7] Treas. Reg. §1.21-1(c)(1).

[8] Treas. Reg. §1.21-1(e)(1).

[9] Treas. Reg. §1.21-1(d)(6).

[10] IRC Sec. 21(e)(9).

Why is this Topic Important to Wealth Managers? This topic presents discussion on the individual and nonbusiness deductions offered under the Internal Revenue Code.  Since April 15^th is fast approaching, it is important to review common tax positions with regards to client planning. 

In addition this blogticle presents a excerpted preview of new, updated material from Advanced Markets which will be available soon (see www.advisorfx.com).   Over the coming 9 months, the entire AUS service is being revised and will be rolling out monthly.  The updating will include many new areas and a sharper focus with practical explanations and client presentation aides for current areas.  We look forward to helping you secure your next sale.  

An expense of an individual may be business, nonbusiness, or personal, depending upon which of the individual’s spheres of activity gave rise to the expense.  This Blogticle discusses personal and nonbusiness expenses generally. 

Personal Expenses

Personal expenses are all expenses incurred by an individual that are not business or nonbusiness expenses. These would include, for example, food and clothing for the individual and his family, repairs on the family home, and premiums paid on the individual’s personal life insurance. Generally, no deduction is permitted for personal expenses. [1] By specific statutory provision, however, deductions are allowed for some personal expenses, such as certain personal taxes, a limited amount of charitable contributions, medical expenses, certain interest on a principal residence, and alimony.

Most deductible personal expenses are “itemized deductions” and thus may be taken only if the taxpayer chooses to itemize his deductions instead of claiming the standard deduction.

Nonbusiness Expenses

A nonbusiness expense is generally an investment expense incurred in connection with the production of income, other than a trade, business or profession. Expenses of this type would include, for example, fees for tax or investment advice, and the cost of a safe deposit box used to store taxable securities. The deduction of nonbusiness expenses is governed by Code section 212. Specifically, Section 212 allows a deduction for expenses incurred in connection with: (1) the production or collection of income; (2) the management, conservation, or maintenance of property held for production of income; or (3) the determination, collection or refund of any tax.

The deductibility of nonbusiness expenses may be limited or deferred if they arise in connection with a “passive activity” or are interest expenses. Very generally, a “passive activity” is any activity which involves the conduct of a trade or business in which the taxpayer does not “materially participate.” [2] A passive activity also includes any rental activity, without regard to whether the taxpayer materially participates in the activity. Special rules apply to rental real estate activities. Aggregate losses from “passive activities” may generally be deducted in a year only to the extent they do not exceed aggregate income from passive activities in that year; credits from passive activities may be taken only against tax liability allocated to passive activities. Disallowed losses and credits may be carried over to offset passive income in later years. [3]

Once other limitations have been applied to the deductibility of nonbusiness expenses (e.g., the passive loss rule), they are generally deductible only to the extent that the aggregate of these and other “miscellaneous itemized deductions” exceeds 2% of adjusted gross income. “Miscellaneous itemized deductions” are deductions from adjusted gross income other than deductions for (1) interest, (2) taxes, (3) non-business casualty losses and gambling losses, (4) charitable contributions (including charitable remainder interests), (5) medical and dental expenses, (6) impairment-related work expenses for handicapped employees, (7) estate taxes on income in respect of a decedent, (8) certain short sale expenses, (9) certain adjustments under the Code’s claim of right provisions, (10) unrecovered investment in an annuity contract, (11) amortizable bond premium, and (12) certain expenses of cooperative housing corporations. [4]

A nonbusiness expense must also be “ordinary and necessary” to be deductible. [5] It must, therefore, be reasonable in amount and must bear a reasonable and proximate relation to (a) the production or collection of taxable income, or (b) the management, conservation, or maintenance of property held for the production of income. [6]

Tomorrow’s blogticle will discuss important planning aspects of 2011. 

We invite your opinions and comments by posting them below, or by calling the Panel of Experts 

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[1] IRC Sec. 262(a).

[2] IRC Sec. 469(c).

[3] IRC Sec. 469(b). 

[4] IRC Sec. 67(b).

[5] IRC Sec. 212.

[6] Treasury Reg. §1.212-1(d).

Why is this Topic Important to Wealth Managers? Discusses Internal Revenue Code Section 179 in relation to the Obama Tax Cuts.  Presents analysis of a common transaction used by small business when acquiring capital assets.

Last month we discussed Section 179 in conjunction with year-end tax planning.   As a general matter of review, businesses may take “annual deductions for depreciation and amortization to the extent they represent a reasonable allowance for the exhaustion, wear and tear of property used in a trade or business or held for the production of income.” [1] This concept is based on the matching of the actual use of the property as a deductible expense.

However, earlier this year, Congress enacted the Small Business Jobs Act of 2010, [2] which included several changes in areas concerning the tax law, in part regarding Section 179. [3]

Specifically, the Small Business Jobs Act, “increased the maximum amount deductible under [Internal Revenue Code] Section 179 which allows, under certain situations, for the expense of generally depreciable assets.” [4]

Therefore, subject to certain limitations, a taxpayer that invests in certain qualifying property may elect under section 179 to deduct (or “expense”) the cost of qualifying property, rather than to recover such costs through annual depreciation deductions occurring over the useful life of the asset.

As was discussed in an earlier blogticle, for taxable years beginning in 2010 and 2011, the maximum amount that a taxpayer may expense is $500,000 of the cost of qualifying property placed in service for the taxable year.  The $500,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $2,000,000. [5]

Section 402 of the Tax Relief, Unemployment Insurance Reauthorization, And Job Creation Act of 2010 [6], amended certain deductible amounts with regards to section 179 that become effective beginning in 2012.

The new law states that, for taxable years beginning in 2012, the maximum amount a taxpayer may expense, under Section 179, is $125,000 of the cost of qualifying property placed in service for the taxable year. The $125,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $500,000.

Furthermore, the new law states that, for taxable years beginning in 2013, and thereafter, the maximum amount a taxpayer may expense under Section 179 is $25,000 of the cost of qualifying property placed in service for the taxable year.  The $25,000 amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the taxable year exceeds $200,000.

Tomorrow’s blog will continue to discuss pertinent provisions of the new Tax Cuts.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] AdvisorFX.  Business Income and Deductions (AUS Main Section 19, B4). http://www.advisorfx.com/articles/f19_1_8_3260.aspx?action=13.  Citing, 26 C.F.R. §1.167(a)-1, 26 U.S.C. §§167, 168, 169, 179 and related regulations.

[2] H.R. 5297.  http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h5297enr.txt.pdf.  Last Accessed 11/8/2010.

[3] H.R. 5297. Section 2021.

[4] Business West. Year-end Tax Planning.  http://businesswest.com/2010/11/year-end-tax-planning. 09 November 2010.   Last Accessed 11/8/2010; 113 Journal of Taxation 195.

[5] 26 U.S.C. § 179 (b)(1)(B).

[6] HR. 4853.

Why is this Topic Important to Wealth Managers?  As the end of the calendar and personal tax year approaches, Advanced Market Intelligence will focus on end-of-the-tax-year issues that every wealth manager may relay as helpful information to his and her clients.

“How are business expenses reported for income tax purposes?” may initially seem like an easy question for many wealth managers.  But normally, the easiness of answering this question is a result of referring to an information pamphlet by a service provider or perhaps a newspaper article.  Unfortunately, these public sources of information are not always accurate.  Also, because they are trying to present very complex information in understandable terms, these types of sources gloss over finer, yet very important elements, that if known, would impact a decision.

Seldom does the wealth manager take the initiative to undertake his own initial research of the actual rules and how the rules may be applied.  Advanced Market Intelligence has been committed to empowering the wealth manager with the necessary information to efficiently find the important rules and provide examples of how the rules are applied to various example scenarios.  Thus, let us first turn to the legislative rule applying to business expenses.

The Internal Revenue Code (the “Code”), legislated by Congress, establishes rules regarding ‘if and when’ a taxpayer may choose to deduct certain expenses from income.  Congress grants the authority to the Treasury department to write corresponding “Regulations” to address the administration and enforcement surrounding the ability of taxpayers to take such deductions allowed by the Code.  Business expenses are one type of such expense Congress has established for a taxpayer to reduce his gross income.

The Code section establishing the ability of a taxpayer to deduct a business expense is Section 162.  The first part of the first paragraph of Section 162 reads:

(a) In general

There shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business, including— …

In that most taxpayers do not hold a degree specialized in taxation, many will find the Code’s terminology and sentences confusing. An obvious example of a term and a phrase in the first part that may confuse a taxpayer is “ordinary” and “necessary”.  What makes an expense “ordinary” instead of “not” ordinary?  The same can be asked of “necessary”.  And the phrases contains the word “and” which normally is a ‘conjunctive’ (recalling back to high school grammar lessons), meaning that the taxpayer must determine if an expense is both ordinary “and” necessary in order to claim it as a deduction.

The Federal government’s business portal Business.gov provides the following response to the question of what is an ordinary and a necessary expense:  ”An ordinary expense is one that is common and accepted in your field of business.  A necessary expense is one that is helpful and appropriate for your business.”

We can spend a week just digesting the terms “ordinary” and then “necessary”.  But that’s just the start of our investigation and the exercise of assisting a client.  We would require several days examining the terms “paid” or “incurred”; another few days on “taxable year” and finally “trade” or “business”.  By example, because Congress includes the possibility of deduction for either a “trade” or a “business”, a taxpayer will be inclined to ask: “What’s the difference between a trade and a business?”  A taxpayer may think Congress is being repetitive, but normally each word has its own, even important, significance on the application of the Code Section to the taxpayer’s specific situation.

And it quickly goes downhill from there.  The Code Section evolves from this, albeit not simple, somewhat manageable part into a morass of limitations, exceptions to the limitations, and exceptions to the exceptions.  This Code section continues for more than 5,000 words and more than 10 pages to establish when a taxpayer may deduct a business expense.

So by example, immediately following the above part, Congress includes:

(1) a reasonable allowance for salaries or other compensation for personal services actually rendered;

(2) traveling expenses (including amounts expended for meals and lodging other than amounts which are lavish or extravagant under the circumstances) while away from home in the pursuit of a trade or business; and

(3) rentals or other payments required to be made as a condition to the continued use or possession, for purposes of the trade or business, of property to which the taxpayer has not taken or is not taking title or in which he has no equity.

Over this next week, Advanced Market Intelligence will distill this Code Section in relation to  some of the common scenarios that a wealth manager and his client will face.  By example – when is my travelling the “travelling” that Congress includes under (2) above?

Fortunately, for the 173,000 insurance industry and wealth management subscribers of National Underwriters publications and information services, they can obtain access to Advanced Market Intelligence (AdvisorFX) to be able to present to clients and prospects opportunities for deduction of business expenses, and respond to clients and prospects questions before bringing in the tax expert (and the costs associated).

Read the key information you need to know and relate to your client at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber):

Tax Facts 7537. How are business expenses reported for income tax purposes?

Main Library - Section 19. Income Taxes B4—Business Income And Deductions

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

Why is this Topic Important to Wealth Managers? Discusses the key differences and similarities to the treatment for the deduction of an insurance contract premium payment with regards to accrual basis taxpayers with that of the cash receipts and disbursement method.

Today’s blogticle continues our week long series on year-end tax planning for businesses and individuals.  Specifically we pick up right where we left off yesterday, except today’s focus is on accrual basis taxpayers with regards to prepaid expenses.

Accrual taxpayers are treated slightly different than cash taxpayers when it comes to prepaid expenses, and in fact the process can sometimes add complications.  The idea behind accrual accounting is to match revenues with expense in the period in which they occur.  For a detailed discussion on the difference between cash and accrual taxpayers see our August 23 blogtice: Advisor FYI: Accounting for Corporations and Limited Liability Companies and How it Relates to Insurance

As was discussed yesterday, an ordinary and necessary expense is deductible when it is paid or incurred in the taxable year for the purpose of carrying on a trade or business.  [1]

One such class of deductions that is generally allowable is, “insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business, and rental for the use of business property.” [2]

Generally, an accrual basis taxpayer, unlike cash method taxpayers, may deduct a business expense in the first year in which the taxpayer “incurs,” or becomes liable for, that expense, regardless of when the taxpayer actually pays for the expense. [3] Whether a taxpayer has incurred an expense is governed by the “all events” test.  Under this test, all the events must have occurred that establish the liability, and the amount must be capable of being ascertained with reasonable accuracy. [4]

Furthermore, in “determining whether an amount has been incurred with respect to any item during any taxable year, the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs.” [5]

Economic performance with regard to insurance, warranty or service contracts, occurs when “payment is made to the person to which the liability is owed.” [6] “The term payment has the same meaning as is used when determining whether a taxpayer using the cash receipts and disbursements method of accounting has made a payment.” [7]

On its face, one may consider how the tax law treats insurance contract premium payments for cash receipts and disbursements method of accounting with that of an accrual election, and note that the deduction for both cash and accrual taxpayers occurs when the payment of cash or cash equivalents is made.  The short answer is, the law has conflated the two and there is no significant difference in the timing of this accrual deduction as compared to cash basis taxpayers, discussed yesterday.

This also means that an accrual based taxpayer may take a deduction in the year the premium is paid, and if the contract is for less than 12 months, the taxpayer need not capitalize and amortize the premium over the life of the contract. [8]

Tomorrow’s blogticle will continue the year-end tax planning series.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] 26 U.S.C. § 162 (a); Neonatology Associates, P.A. v. C.I.R.  115 T.C. 43, 88 (U.S.Tax Ct.,2000) Citing,  Commissioner v. Lincoln Savs. & Loan Association, 403 U.S. 345, 352, 91 (1971); Welch v. Helvering, 280 U.S. 111, 115, (1933).

[2] 26 C.F.R. § 1.162-1; U.S. v. Weber Paper Co., 320 F.2d 199, 63-2 U.S. Tax Cas. (CCH) P 9630, 12 A.F.T.R.2d 5256 (8th Cir. 1963).

[3] Treas.Reg. § 1.461-1(a)(2); United States v. Anderson, 269 U.S. 422, 424, 46 S.Ct. 131, 70 L.Ed. 347 (1926).

[4] 26 C.F.R. § 1.461-1(a)(2); Valero Energy Corp. v. C.I.R.  78 F.3d 909, 915 (C.A.5,1996).  See also, U.S. v. General Dynamics Corp. 481 U.S. 239, 243 U.S.,1987).

[5] 26 U.S.C. § 461(h)(1).

[6] 26 C.F.R. § 1.461-4 (g)(5).

[7] 26 C.F.R. § 1.461-4 (g)(1)(ii).

[8] 26 C.F.R. § 1.263(a)-4 (f)(1).

Why is this Topic Important to Wealth Managers? Generally, wealth managers can help identify situations where clients may benefit from one or more concepts, and present ideas to clients as part of a comprehensive planning partnership.  This blogticle discusses on way in which wealth managers can contribute to client tax planning discussion. 

As December 31 approaches we would like to take this opportunity to discuss some of the common tax planning concepts that are used by professionals in an effort for legal tax mitigation.  Therefore, this week’s blogticles discuss year-end tax planning for businesses and individuals.  Today’s blogticle kicks off our discussion with pre-paid expenses for cash disbursements and receipts method taxpayers. 

As with all transactions, it should be kept in mind that the transaction, to comply with Federal tax law, needs to change the taxpayers “economic position” in a meaningful way not including any tax benefits, and the taxpayer has a” substantial purpose” for entering the transaction not including any tax considerations. [1] Satisfying the above conditions is commonly referred to as a transaction that contains economic substance. 

For more information on the economic substance doctrine, please see our October 29^th AdvisorFYI blogticle entitled: One More to Note: The Economic Substance Doctrine, as well as: AdvisorFX: The Economic Substance Doctrine Can Unwind Even the Best Laid Plans . 

Traditionally, taxable income of a business is computed by its gross income less its deductions and exclusions. [2]  Generally, gross income means all income from whatever source derived unless otherwise excluded by law. [3]  Congress allows for a “deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” [4]

The taxpayer has the burden to show that the item claimed as a deductible business expense: 1) was paid or incurred during the taxable year; 2) was for carrying on its trade or business; 3) was an expense; 4) was a necessary expense; and 5) was an ordinary expense. [5] 

One such class of deductions that is generally allowable is, “insurance premiums against fire, storm, theft, accident, or other similar losses in the case of a business, and rental for the use of business property.” [6]

There is a general rule that cash receipts and disbursements method taxpayers may deduct expenses when actually paid in cash. [7]

Can the taxpayer deduct the entire amount paid, if reasonable, for a benefit that expires within a 12 month period, or must the expense be capitalized and depreciated over its useful life? 

The Treasury Regulations state, “a taxpayer is not required to capitalize…amounts paid to create [a] benefit for the taxpayer that does not extend beyond…12 months after the first date on which the taxpayer realizes the right or benefit”. [8]

Compare the 12 month standard to “[a] prepayment for multiyear insurance coverage creates an asset having a useful life longer than a taxable year, which must be capitalized.” [9]  The former is generally fully deductible in the year paid, the latter is not. 

Tomorrow’s blogticle will discuss pre-paid expense for accrual method taxpayers. 

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] 26 U.S.C. § 7701(o). 

[2] 26 U.S.C. § 63 (a). 

[3] 26 U.S.C. § 61(a). 

[4] 26 U.S.C. § 162 (a)   

[5] Neonatology Associates, P.A. v. C.I.R.  115 T.C. 43, 88 (U.S.Tax Ct.,2000) Citing, See Commissioner v. Lincoln Savs. & Loan Association, 403 U.S. 345, 352, 91 S.Ct. 1893, 29 L.Ed.2d 519 (1971); Welch v. Helvering, 280 U.S. 111, 115, 50 S.Ct. 49, 74 L.Ed. 217 (1933).

[6] 26 C.F.R. § 1.162-1; U.S. v. Weber Paper Co., 320 F.2d 199, 63-2 U.S. Tax Cas. (CCH) P 9630, 12 A.F.T.R.2d 5256 (8th Cir. 1963).

[7] 26 C.F.R. § 1.461-1(a)(1); Eckert v. Burnet  283 U.S. 140, 141, 51 S.Ct. 373, 374 (U.S., 1931); Chapman v. U.S., 527 F. Supp. 1053, 1054 82-1 U.S. Tax Cas. (CCH) ¶9119, 49 A.F.T.R.2d 82-443 (D. Minn. 1981).  

[8] 26 C.F.R. § 1.263(a)-4 (f)(1). 

[9] Toyota Town, Inc. v. C.I.R.  L 140819, 9 -10  (U.S.Tax Ct.,2000), citing Higginbotham-Bailey-Logan Co. v. Commissioner, 8 B.T.A. 566, 577 (1927);  26 C.F.R. §  1.461-4(g)(8), Example (6).; see also USFreightways Corp. v. Commissioner, 113 T.C. —-, (1999); Johnson v. Commissioner, supra at 488; Hinshaw’s, Inc. v. Commissioner, T.C. Memo.1994-327.