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Innovative Tax Planning for Individuals and Sole Proprietors

Author/Moderator: William R. Bischoff, MBA, CPA
Publisher: AICPA
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Description

This course has been updated to include content on the Emergency Economic Stabilization Act of 2009

This information-packed course is brimming with the latest innovative techniques for building and conserving wealth, employing beneficial tax planning and investment strategies. AICPA tax experts dissect the details of the most current tax laws and other new developments to extract every sliver of tax benefits.

Objectives: 
  • Increase client wealth by focusing on tax-saving angles and exploring investment opportunities
  • Recognize planning opportunities to be found in new and recent tax developments
  • Use tax law changes to your client’s best advantage

Prerequisite:  Basic knowledge of individual income taxation

Accepted for PFS credit.

Table of Contents

  • Chapter 0 - Overview
    • Introduction
    • Organization
    • Conclusion
  • Chapter 1 - Maximizing Tax Benefits for Sales of Capital Gain Assets and Real Property
    • Learning Objectives
    • Introduction
    • Capital Gains Tax Rates in a Nutshell
      • Reduced Capital Gains Rates for Sales through 2010
      • Some Gains Do Not Qualify for Reduced Rates
      • Alternative Minimum Tax (AMT) Treatment of Capital Gains
      • Qualified Dividends Taxed at Capital Gains Rates, Too
      • Not All Dividends Are Eligible for Reduced Rates
      • Reduced Ordinary Income Rates, Too – But Long-Term Capital Gains and Qualified Dividends Are Taxed Less
      • Many Individuals Occupy 10% and 15% Brackets and Pay Only 0% on Their Investment Profits
    • Tax-Smart Investing Strategies
      • Tax-Smart Strategies for Capital-Gain Assets
      • Tax-Smart Strategies for Fixed-Income Investments
      • Borrowing to Buy Dividend-Paying Stocks Is Usually Inadvisable
      • Variable Annuities Are Damaged Goods
    • Installment Sales of Capital and Section 1231 Assets
      • Installment Sales of Depreciable Real Estate
    • Planning for Year-End Dispositions of Securities
      • Planning for Year-End Mutual Fund Transactions
      • Donate Appreciated Stock, Sell Loss Stock
      • Other Year-End Considerations
    • More on Tax Planning for Mutual Funds
      • What Sale?
      • Calculating Mutual Fund Share Basis
      • FIFO Method
      • Average Basis
      • Foreign Taxes on International Funds
    • Netting Rules and Dispositions of Section 1231 Property
    • Converting Capital Gains and Qualified Dividends into Ordinary Income to Maximize Investment Interest Writeoffs
    • Special Breaks for Sales of Qualified Small Business Stock
      • AMT Preference for Pre-2011 Sales
      • AMT Preference for Post-2010 Sales
    • Planning for Capital Gain Treatment for Subdivided Lot Sales
      • Restrictions on Section 1237 Relief
      • Definition of "Tract of Real Property"
      • Definition of "Substantial Improvement"
      • Election to Disregard Substantial Improvements
      • The Six Lot Rule
    • Using a "Developer Entity" to Convert Ordinary Income into Capital Gains
    • Escaping Gains Altogether with a Like-Kind Exchange
      • Like-Kind Exchange Basics
      • Realized Versus Recognized and Receipt of Boot
      • Basis and Holding Period for Like-Kind Property Received
      • Effect of Liabilities
      • Deferred Like-Kind Exchanges
      • Tax Rules for Deferred Exchanges
      • Avoiding Constructive Receipt Problems with Escrow Arrangements
      • Four-Party Exchanges with Qualified Intermediaries
      • "Reverse Starker Exchanges" Are Now Clearly Allowed
    • Summary
    • Questions
  • Chapter 2 - Planning for Employer Stock and Stock Options
    • Learning Objective
    • Introduction
    • Employer Stock Options
      • Buying and Selling ISO Shares
      • AMT Rules for ISO Shares
      • Disqualifying Dispositions of ISO Stock
      • Liberalized AMT Credit Rules for 2008-2012 Will Help Those Who Exercised Lucrative ISOs in Prior Years
      • Nonqualified Stock Options (NQSOs)
      • Hold That Option, Version 1
      • Hold That Option, Version 2
    • Federal Payroll Tax Implications of Employer Options
      • Nonqualified Options
      • Incentive Stock Options
    • Year-End Sale of ISO Shares Can Avoid Unfair AMT Hit
      • But Watch Out for This!
    • Employer Stock from Qualified Retirement Plan Distributions
      • Withdraw Shares and Hold in Taxable Account
      • Rollover into IRA
    • Summary
    • Questions
  • Chapter 3 - How Clients Can Manage Their Investment Accounts to Save Taxes
    • Learning Objective
    • Introduction
    • Placing the Right Assets in the Right Accounts
      • Outcome for Option 1 (Fixed Income Assets in Roth IRA)
      • Outcome for Option 2 (Fixed Income Assets in Tax-Deferred Account)
      • Outcome for Option 3 (Fixed Income Assets in Taxable Account)
      • Conclusions
      • One More Advantage for Roth IRAs
    • Contributing to Tax-Deferred Retirement Accounts Is Still the Tax-Smart Move
      • Argument
      • Outcome for Strategy 1 (Make Retirement Account Contribution)
      • Outcome for Strategy 2 (Skip Retirement Account Contributions and Invest in Taxable Account)
      • Conclusions
    • Holding Treasury Inflation-Protected Securities (TIPS) in Retirement Accounts
      • TIPS to the Rescue
      • How TIPS Work
      • Be Careful When Buying TIPS
      • Understand the Tax Implications
      • How to Buy TIPS
      • Conclusion
    • A Few Words about the "Tax Efficiency" of Mutual Funds
      • The Problem with Those Darned Funds
      • Enter "Tax-Efficient" Funds
      • So What Should Investors Do?
      • Additional Mutual Fund Tax Considerations
    • Deducting IRA Losses
      • When Can Traditional IRA Losses Be Deducted?
      • When Can Roth IRA Losses Be Deducted?
      • Beware of 10% Penalty Tax When Liquidating Roth IRAs with Conversion Contributions
      • Here Are Some Examples
      • Conclusion
    • Summary
    • Questions
  • Chapter 4 - All About IRAs
    • Learning Objectives
    • Introduction
    • Roth IRA Basics
      • Larger Contribution Limits
      • Should Your Client Convert?
      • Conversion Details
      • How to Handle Roth IRA Withdrawals
    • Planning around the IRA Required Minimum Distribution Rules
      • Required Minimum Distribution Rules for Original Account Owners
      • When Spouse's Account Is Inherited: Calculating Surviving Spouse's Required Minimum Distributions
    • How to Use a Roth IRA for Estate Planning
    • New Non-Spousal IRA Rollover Privilege
      • General Rollover Mechanics
      • Required Minimum Withdrawal Rules Apply to Receiving IRA
      • Special Considerations When Plan Participant Dies Before RBD
      • Rollover Mechanics When Plan Participant Dies Before RBD
      • Non-Spousal Rollover Conclusions
    • Qualified Charitable Distributions (QCDs)
      • What Constitutes a QCD?
      • Sunset and Annual Limitation Rules
      • IRA Beneficiaries Can Do QCDs Too
      • QCDs Offer Income and Estate Tax Advantages
      • Who Can Benefit?
      • Do QCDs from Roth IRAs Make Sense?
      • “Bad Old Rules” Will Return in 2010 Unless Congress Acts
    • Summary
    • Questions
    • Appendix – Converting the IRA or Standing Pat
  • Chapter 5 - Maximizing Tax Benefits for Home Sales
    • Learning Objectives
    • Introduction
    • Qualification Rules for Gain Exclusion Privilege
      • Ownership and Use Tests
      • What Is a Principal Residence?
      • Gain Exclusion Rules for Married Couples
      • Special Exception for Unmarried Surviving Spouses May Permit Larger $500,000 Gain Exclusion
      • Anti-Recycling Rule
      • Prorated (Reduced) Gain Exclusion Loophole for "Premature" Sales
    • Claiming Exclusion for Home Used Partly for Business or Rental
      • Premature Sale of Property Used for Business or Rental
    • Excluding Gain from Sale of Land Next to Residence
    • Excluding Gains in Marriage and Divorce Situations
      • Sale after Marriage
      • Sale before Divorce
      • Sale in Year of Divorce or Later
      • When "Nonresident Ex" Continues to Own Home Long after Divorce
    • "Electing Out" of Gain Exclusion Privilege
    • Understanding the Tax Implications of Personal Residence Short Sales and Foreclosures and the Exclusion for Cancellation of Debt Income from Principal Residence Mortgages
      • Tax Rules for Cancellation of Debt Income
      • What If the Lender Forecloses?
      • Exclusion for Principal Residence Mortgage Debt Discharges Will Save the Day for Many Clients
    • Temporary First-Time Homebuyer Credit
      • Eligibility Rules
      • Phase-Out for Higher-Income Taxpayers
      • Credit Must Be Repaid
      • Greatly Liberalized Rules for 2009 Purchases (New Law)
      • Credit Still Must Be Repaid in Some Cases (New Law)
      • Election to Claim Credit for 2009 Purchase on 2008 Return (New Law)
    • Summary
    • Questions
  • Chapter 6 - Planning Opportunities with Vacation Homes and Timeshares
    • Learning Objective
    • Introduction
    • "Regular" Vacation Homes
      • Category 1: Rented More than 14 Days – and Personal Use Exceeds Greater of 14 Days or 10% of Rental Days
      • Category 2: Rented More than 14 Days – and Personal Use Does not Exceed Greater of 14 Days or 10% of Rental Days
      • Category 3: Rented Less than 15 Days – and Personal Use Exceeds 14 Days
    • Tax Planning for Category 2 Properties
    • Timeshares and Co-Ownership of Vacation Homes
      • No Rental Days
      • Some Rental Days
      • Tax-Free Rent Rule
    • Playing the Gain Exclusion Game with Multiple Residences
      • Unfavorable New Rule for Properties Converted into Principal Residences after 2008
    • Summary
    • Questions
  • Chapter 7 - Tax Planning for Marital Splits
    • Learning Objective
    • Introduction
    • Separate Versus Joint Returns for Pre-divorce Years
      • Marriage Penalty Relief
      • Filing Separately to Avoid Liability for Ex-Spouse's Tax "Mistakes"
      • Filing Separately as Head of Household
      • Other Ways to Avoid Tax Liabilities Caused by Spouses
    • Timing of the Divorce – This Year or Next?
      • Allocations of Taxable Income, Deductions, Tax Payments, Etc.
      • Head of Household Status in Year of Divorce
      • Divorcing before Year-End to Avoid Marriage Penalty
      • Postponing Divorce to Collect "Marriage Dividend"
    • Avoiding Pre-Divorce Tax Fiascos with IRA and Qualified Retirement Plan Assets
    • Planning to Achieve Tax-Effective Splits of IRA and Qualified Retirement Plan Assets
      • Splitting up IRA Assets
      • Splitting up Qualified Retirement Plan Account Assets
    • Planning to Achieve Equitable After-Tax Property Divisions
      • Taking Advantage of the Tax-Free Transfer Rule
      • Assignments of Income Are Not Property Transfers
    • Planning for Children's Dependent Exemption Deductions
    • Planning to Qualify Payments as Deductible Alimony
      • Requirements for Payments to Constitute Alimony
      • Alimony Received Is Earned Income for IRA Contribution Purposes
      • Avoiding Characterization of Payments as Child Support
      • Avoiding Alimony Recapture
    • Summary
    • Questions
    • Practice Aids
      • Practice Aid 7-1: Divorce Tax Planning Checklist
      • Practice Aid 7-2: Client Letter Regarding Separate Returns
      • Practice Aid 7-3: Client Letter Regarding Timing of Divorce
      • Practice Aid 7-4: Letter to Attorney Contacts Regarding Dividing IRA and Qualified Retirement Plan Assets
      • Practice Aid 7-5: Checklist to Make Sure Payments Qualify as Deductible Alimony
  • Chapter 8 - Tips for Self-Employed Clients
    • Learning Objectives
    • Introduction
    • Choice of Business Entity
      • Sole Proprietorships
      • Single-Member Limited Liability Companies (LLCs)
      • S Corporations
      • Regular Corporations (C Corporations)
      • Qualified Small Business Corporations (QSBCs)
      • Multi-Member LLCs
      • Limited Liability Partnerships (LLPs)
      • General Partnerships
      • Limited Partnerships
    • "Heavy" Sport Utilities, Pickups, and Vans Can Be Tax-Saving Machines
      • Maximum Deductions for Cars with Bonus Depreciation
      • Maximum Deductions for Cars without Bonus Depreciation
      • Maximum Deductions for Light Trucks and Light Vans with Bonus Depreciation
      • Maximum Deductions for Light Trucks and Light Vans without Bonus Depreciation
      • Reduced Section 179 Deduction for Heavy SUVs
      • Despite $25,000 Limitation, Depreciation Rules for Heavy SUVs Are Still Very Favorable
      • First-Year Bonus Depreciation Is Back (Temporarily)
      • Do Not Forget Section 179 Taxable Income Limitation
      • Do Not Forget Section 179 Deduction Phase-out Rule
      • Mind Stricter Rules for Corporate-Owned Vehicles
      • Other Caveats
    • Planning to Reduce Self-Employment and FICA Taxes
      • Employing Owner’s Children in the Business
      • Beating the System by Incorporating
    • Games You Can Play with Health Benefits
      • A Potential Solution for Sole Proprietors and Single-Member LLCs
      • Partnerships and Multi-Member LLCs
      • S Corporations
    • What to Do When Spouses Are Active in the Self-Employment Activity
      • More on the Federal Tax Status of Unincorporated Businesses
      • Self-Employment Tax Planning Opportunities in Community Property States
      • Simplified Tax Compliance for Qualified Husband-Wife Joint Ventures
    • Summary
    • Questions
  • Chapter 9 - Tax-Wise College Financing for Middle-Class Clients
    • Learning Objective
    • Introduction
    • Education Tax Credits
      • The Old-Law Hope Scholarship Credit (for 2008)
      • The New Modified Hope Scholarship Credit (for 2009 and 2010)
      • The Lifetime Learning Credit
      • Rules Applying to Both Credits
      • Beating the System
    • Deduction for Student Loan Interest
    • Coverdell Education Savings Accounts
    • Deduction for College Tuition and Related Fees
    • Tax-Free Employer Reimbursements for Higher Education Costs
      • Penalty-Free IRA Withdrawals
    • Using Tax-Free Interest from U.S. Savings Bonds
      • Qualifying Savings Bonds
      • Qualifying Expenses
      • Computing the Amount of Excluded Interest
      • Those Nasty Phaseout Rules for Higher-Income Taxpayers
      • Conclusion on the Savings Bond Tax Break
    • Electing the Accrual Method for U.S. Savings Bonds
      • How to Make the Election
    • Summary
    • Questions
  • Chapter 10 - Tax-Savings College Financing Maneuvers for High-Income Clients
    • Learning Objective
    • Introduction
      • Splitting Investment Income with the Kids
      • The Dreaded Kiddie Tax Rules
      • Saving for College Using Parent’s Taxable Account
    • Saving for College Using Child’s Roth IRA
    • Financing College with Deductible Payments from the Parent's Business
    • How a Closely Held Business Can Deduct College Expenses Paid for the Owner's Adult Child
      • Meeting the Qualification Rules
      • Dodging the 5% Ownership Bullet
    • State-Sponsored Qualified Tuition Programs (Section 529 Plans)
      • How College Savings Plans Work
      • The Tax Benefits
      • Investment Restrictions and Withdrawal Penalties
      • Which State Plan Is Best?
      • Deducting Section 529 Plan Losses
    • "Last-Minute" Suggestions for Procrastinators
      • Home Equity Loans
      • Gift Appreciated Assets; Sell Loss Assets
      • Tap into IRA Funds
      • Take Advantage of Direct Gifts
    • Summary
  • Chapter 11 - Latest Developments

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Excerpts

Chapter 0 - Overview

Introduction

This course describes and illustrates practical tax-planning techniques in several key individualtax areas. Many of the techniques covered in the course may be applied across a wide range of taxpayer income levels.

Organization

Topic by topic, you will be guided through tax-saving techniques and strategies that are illustrated by practical examples. Where alternate strategies exist, you will review the advantages and disadvantages of each, so that you may assist your clients in making appropriate choices.

Most chapters have questions to reinforce the concepts covered in the chapter. In addition, Chapter 7, which covers planning strategies relating to divorce, contains a series of practice aids that you may adapt to your own practice needs.

Conclusion

The manual is designed to be a permanent reference tool. We hope your reading of this manual enriches your professional learning experience.

Note. We use the terms he and she alternately throughout the course (except when a particular person is mentioned) since both sexes are well represented throughout the profession.

Chapter 1 - Maximizing Tax Benefits for Sales of Capital Gain Assets and Real Property

Learning Objectives

• Negotiate the intricacies of the current tax structure for capital gains to help clients maximize their tax savings when buying and selling capital and §1231 assets.

• Help clients take advantage of the special §1237 tax break for real estate subdividers.

• Help real estate owners take advantage of the tax-deferred like-kind exchange provisions of IRC §1031.

Introduction

This chapter covers what practitioners need to know from both planning and compliance perspectives to help clients maximize tax savings under the current rate structure for capital gains, which is effective through 2010 (unless Congress changes its mind).

In addition, this chapter covers a special exception under IRC §1237, which grants capital gain treatment to certain sellers of subdivided lots. With today's low capital gains rates and an abundance of built-in real estate gains (despite recent market declines in many areas), the §1237 exception continues to be an important break for landowners.

Finally, this chapter covers §1031 like-kind exchanges for clients who are obsessed with outright avoidance of capital gains taxes.

Capital Gains Tax Rates in a Nutshell

After repetitive law changes, the federal income tax rates on capital gains are more confusing than ever. That said, the current rates are also more beneficial than ever.

Key Point. The author does not expect all of the current individual federal tax rate structure to stay in place beyond 2010. Predictions (for what they are worth) are made, at the time of this update, in appropriate places throughout the discussion that follows.

Reduced Capital Gains Rates for Sales through 2010

Thanks to the Jobs and Growth Tax Relief Reconciliation Act of 2003 (the 2003 Act) and the Tax Increase Prevention and Reconciliation Act (TIPRA), most long-term capital gains earned by individuals through the end of 2010 will be taxed at significantly lower federal income tax rates. The reduced rates also apply to the deferred capital gain component of installment note principal payments received by sellers after May 5, 2003 and before 2011. Specifically,

• Most long-term capital gains are taxed at a maximum rate of only 15%.

• For 2008-2010, most long-term capital gains that would otherwise fall within the 10% and 15% ordinary income rate brackets will be taxed at 0%. Now that is an unbeatable rate!

• Many more folks than you might think will pay a marginal ordinary income rate of 10% or 15% and thus be eligible for the 0% rate in 2008-2010. More on that later in this section.

• Gains from the sale of qualified small business corporation (QSBC) stock held for more than six months can be rolled over tax-free if the seller reinvests the proceeds in other newly issued QSBC stock (as explained later in this chapter). This provision is the same as under "old law."

• Capital gains from principal residence sales can be entirely excluded from federal income taxation to the extent of up to $500,000 for joint filers and up to $250,000 for unmarried individuals (assuming the qualification rules are met).

Some Gains Do Not Qualify for Reduced Rates

Unfortunately, the 15%/0% rates were not extended to all types of capital gains. Specifically,

• The reduced rates have no impact on investments held inside a tax-deferred retirement account (traditional IRA, Keogh, SEP, solo 401(k), and the like). So, the client will pay taxes at her regular rate (which can be as high as 35%) when gains accumulated in these accounts are withdrawn as cash distributions. (Gains accumulated in a Roth IRA are still federal-income-tax-free as long as the requirements for tax-free withdrawals are met.)

• Clients will still pay taxes at their higher regular rates on short-term capital gains from investments held for one year or less. These short-term gains still count as ordinary income, just as they did under "old law." Therefore, if the client holds appreciated stock in a taxable account for exactly one year, he could lose up to 35% of his profit to the IRS. If he instead holds on for just one more day, his tax rate drops to no more than 15%. The moral: selling just one day too soon could mean losing up to 20% more of one's profit to the tax collector.

Key Point. For tax purposes, the client's holding period begins the day after he acquires securities and includes the day he sells. For example, say your client buys shares on November 1 of this year. His holding period begins on November 2. Therefore, November 2 of next year is the earliest possible date he can sell and still be eligible for the reduced rates on long-term capital gains. (See Rev. Ruls. 66-7 and 66-97.)

• Section 1231 gains attributable to depreciation deductions claimed against real estate properties are called unrecaptured Section 1250 gains. These gains, which would otherwise generally be eligible for the 15% maximum rate, are still taxed at a maximum rate of 25% as they were under "old law" [IRC Sec. 1(h)(6)]. The good news: any Section 1231 gain over and above the amount of unrecaptured Section 1250 gain from a real property sale is generally eligible for the 15% maximum rate on long term capital gains. The same treatment applies to the deferred Section 1231 gain component of installment note payments received after May 5, 2003, from an installment sale transaction, even though the sale date may have been before May 5, 2003.

Key Point. Distributions from REITs and REIT mutual funds may include some unrecaptured Section 1250 gains from real property sales. These gains, which are still taxed at a maximum rate of 25%, should be separately reported to the investor and entered on the appropriate line of the investor's Schedule D.

• The "old-law" 28% maximum rate on long-term capital gains from sales of collectibles and QSBC stock remains in force [IRC Sec. 1(h)(5) and (7)].

Sunset Rule. After 2010, the "old-law" capital gains rates will return unless Congress takes further action. The author's best guess is that the existing rate structure on longterm gains will be kept in place except for those in the top two tax brackets. For them, the maximum rate on most long capital gains may increase to 20% (up from the current 15%) for post-2010 years.

Alternative Minimum Tax (AMT) Treatment of Capital Gains

The preferential capital gains rates apply equally for both regular tax and AMT purposes. However, significant capital gains can still push individuals into the AMT mode. Why? Because the additional taxable income from the gains can cause the individual to lose some or all of her AMT exemption due to a phase-out rule. In addition, the additional taxable income from the gains can trigger higher state income taxes. Since the deduction for state income taxes is disallowed under the AMT rules, this increases the odds the individual will owe the AMT.

Qualified Dividends Taxed at Capital Gains Rates, Too

Thanks to the 2003 Act and TIPRA, qualified dividends are now taxed at the same federal income tax rates as long-term capital gains through 2010.

• Qualified dividends are taxed at a maximum rate of 15%.

• For 2008-2010, qualified dividends that would otherwise fall within the 10% and 15% ordinary income rate brackets are taxed at the unbeatable rate of 0%.

• Many more folks than you might think will pay a marginal ordinary income rate of 10% or 15% and thus be eligible for the 0% rate for 2008-2010. More on that later in this section.

Not All Dividends Are Eligible for Reduced Rates

The reduced 15%/0% rates on dividends apply only to qualified dividends paid on shares of corporate stock [IRC Sec. 1(h)(11)]. However lots of payments that are commonly called "dividends" are not qualified dividends under the tax law. For instance,

• Dividends paid on credit union accounts are really interest payments. As such, they are considered ordinary income and are therefore taxed at regular rates . which can be as high as 35%.

• The same is true for dividends paid on some preferred stock issues that are actually publicly traded "wrappers" around underlying bundles of corporate bonds. So clients should not buy preferred shares for their taxable accounts without knowing exactly what they are buying.

• Mutual fund dividend distributions that are paid out of the fund's short-term capital gains, interest income, and other types of ordinary income are taxed at regular rates. So equity mutual funds that engage in rapid-fire trading of low-dividend growth stocks will generate payouts that are taxed at up to 35% rather then at the optimal 15%/0% rates your client might be hoping for.

• Bond fund dividends will also be taxed at regular rates, except to the extent the fund is able to reap long-term capital gains from selling appreciated assets.

• Here is the good news: mutual fund dividends paid out of (1) qualified dividends from the fund's corporate stock holdings and (2) long-term capital gains from selling appreciated securities are eligible for the 15%/0% rates. This means mutual fund annual

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Videocourse Details

NASBA Field of Study: Taxes
Level: Intermediate
Recommended CPE Credit: 15
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