tax consequences

Tax Court Ruling Benefits Small Business Owners

Owners of closely held businesses, including family owned and other small businesses can now pass assets to heirs with minimal taxation thanks to a recent tax court ruling (Wandry v. Commissioner, US Tax Court March 26, 2012).

Under current regulations ownership of the business can be transferred to heirs using yearly and lifetime exemptions ($5,120,000 in 2012), as well as gifting $13,000 per year per heir. The catch is that there must be a professional appraisal of the business, but the IRS can contest the appraised value after the gift is given, and if the IRS finds the value is significantly higher there may be tax consequences.

Here’s what happened.

In 2001 Albert and Joanne Wandry (the donors), and their children formed Norseman Capital, LLC. In 2004, the Wandrys gifted $261,000 of business interests to each of their four children. Each of their five grandchildren received $11,000. The terms specified that the gifts should be equal to the dollar amount of their exemptions, which at the time were $1 million lifetime and an $11,000 annual exclusion.

The Wandrys’ assignation statement stipulated that an independent appraiser would provide valuation for the company, but that if the IRS challenged the valuation and it was determined to be different in a court of law, then the gifted interests would be adjusted to reflect this. This is known as a defined value clause.

In 2006, the IRS audited the couple’s gift tax returns. It appraised the valuation higher than that of the independent appraiser the Wandrys used and said that the gifts now exceeded the exclusion limits. The IRS also argued, among other things, that the defined value clause used in the case was contrary to public policy in part because it discouraged any attempt to collect the tax due.

The tax court disagreed however, and dismissed the argument stating that there was no distinction between a defined value clause in Wandry from that where there was a charitable donee. It also stated that the intent was to make gifts that were equal to their exemptions. As such, there was no additional dollar amount per se, and therefore no tax liability.

Wandry was groundbreaking for a couple of reasons. First, in that the defined value clause had hitherto only been used to reallocate fixed dollar amounts of business interests to charities and not the donors and their children and grandchildren; and second in that when the IRS appraises the business value at a higher amount the difference would not be subject to gift tax, provided the Wandry formulaic model is used.

The lifetime exemption is scheduled to revert to $1 million in 2013, so you might want to consider transferring business assets in 2012 while the exemption is still high. Keep in mind however, that while it’s likely the Wandry case will stand, the IRS has a three month window in which to appeal.

Questions? Give us a call today. We’re happy to help!

Year End Tax Saving Ideas For Individuals – Mutual Fund Investments

Mutual Fund Investments

Before investing in a mutual fund, ask whether a dividend is paid at the end of the year or whether a dividend will be paid early in the next year but be deemed paid this year. The year-end dividend could make a substantial difference in the tax you pay.

Example: You invest $20,000 in a mutual fund at the end of 2011. You opt for automatic reinvestment of dividends. In late December of 2011, the fund pays a $1,000 dividend on the shares you bought. The $1,000 is automatically reinvested.

Result: You must pay tax on the $1,000 dividend. You will have to take funds from another source to pay that tax because of the automatic reinvestment feature. The mutual fund’s long-term capital gains pass through to you as capital gains dividends taxed at long-term rates, however long or short your holding period.

The mutual fund’s distributions to you of dividends it receives generally qualify for the same tax relief as long-term capital gains. If the mutual fund passes through its short-term capital gains, these will be reported to you as “ordinary dividends” that don’t qualify for relief.

Tip: Wait until after the dividend to buy the shares because the share net asset value will drop after the dividend is paid. Alternatively, buy the shares in 2011, but opt to take the dividend in cash instead of having it reinvested.

In spite of these tax consequences, it may be a good idea to buy shares right before the fund goes ex-dividend. For instance, the distribution could be relatively small, with only minor tax consequences. Or the market could be moving up, with share prices expected to be higher after the ex-dividend date.

Tip: To find out a fund’s ex-dividend date, call the fund directly.

Lost Your Job This Year? There Could Be Tax Consequences

Given the current economic conditions, you may be faced with tax questions surrounding a job loss and unemployment issues.

Here are some answers:

Q: What if I received unemployment compensation in 2010?

A: Unemployment compensation you received under the unemployment compensation laws of the United States or of a state must be included in your income. It is taxable income. If you received unemployment compensation, you should receive Form 1099-G showing the amount you were paid and any federal income tax you elected to have withheld.

Q: What if I lost my job?

A: The loss of a job may create new tax issues. Severance pay and unemployment compensation are taxable. Payments for any accumulated vacation or sick time also are taxable. You should ensure that enough taxes are withheld from these payments or make estimated tax payments to avoid a big bill at tax time. Public assistance and food stamps are not taxable.

Q: What if I searched for a job?

A: You may be able to deduct certain expenses you incurred while looking for a new job, even if you did not get a new job. Expenses include travel, resume preparation, and outplacement agency fees. Moving costs for a new job at least 50 miles away from your home may also be deductible.

Q: What if my employer went out of business or in to bankruptcy?

A: Your employer must provide you with a 2010 W-2 Form showing your wages and withholdings by January 31, 2011. You should keep up-to-date records or pay stubs until you receive your Form W-2. If your employer or its representatives fail to provide you with a Form W-2, contact the IRS. They can help by providing you with a substitute Form W-2. If your employer liquidated your 401(k) plan, you have 60 days to roll it over to another qualified retirement plan or IRA.

If you have experienced a job loss and have questions, please call us. You need to be prepared for the tax consequences.

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