Member of Russell Bedford International, a global network of independent professional service firms.
Member of Russell Bedford International, a global network of independent professional service firms.
Mutual funds offer an efficient means of combining investment diversification with professional management. Their income tax effects can be complex, however, and poorly timed purchases or sales can create unpleasant year-end surprises.
Mutual fund investors (excluding qualifying retirement plans) are taxed based on activities within each fund. If a fund investment generates taxable income or the fund sells one of its investments, the income or gain must be passed through to the shareholders. The taxable event occurs on the date the proceeds are distributed to the shareholders, who then owe tax on their individual allocations.
If you buy mutual fund shares toward the end of the year, your cost may include the value of undistributed earnings that have previously accrued within the fund. If the fund then distributes those earnings at year-end, you’ll pay tax on your share even though you paid for the built-up earnings when you bought the shares and thus realized no profit. Additionally, if the fund sold investments during the year at a profit, you’ll be taxed on your share of its year-end distribution of the gain, even if you didn’t own the fund at the time the investments were sold.
Therefore, if you’re considering buying a mutual fund late in the year, ask if it’s going to make a large year-end distribution, and if so, buy after the distribution is completed. Conversely, if you’re selling appreciated shares that you’ve held for over a year, do so before a scheduled distribution, to ensure that your entire profit will be treated as long-term capital gain.
Most mutual fund earnings are taxable (unless earned within a retirement account) even if you automatically reinvest them. Funds must report their annual distributions on Forms 1099, which also indicate the nature of the distributions (interest, capital gains, etc.) so you can determine the proper tax treatment.
Outside the funds, shareholders generate capital gains or losses whenever they sell their shares. The gains or losses are computed by subtracting selling expenses and the “basis” of the shares (generally purchase costs) from the selling price. Determining the basis requires keeping records of each purchase of fund shares, including purchases made by reinvestments of fund earnings. Although mutual funds are now required to track and report shareholders’ cost basis, that requirement only applies to funds acquired after 2011.
When mutual funds are held within IRAs, 401(k) plans, and other qualified retirement plans, their earnings are tax-deferred. However, distributions from such plans are taxed as ordinary income, regardless of how the original earnings would have been taxed if the mutual funds had been held outside the plan. (Roth IRAs are an exception to this treatment.)
If you’re considering buying or selling mutual funds and would like to learn more about them, give us a call.
*This newsletter is issued quarterly to provide you with an informative summary of current business, financial, and tax planning news and opportunities. Do not apply this general information to your specific situation without additional details and/or professional assistance.
To expense or to capitalize? If you buy, build or repair business assets, you might ask that question when deciding whether your costs are currently deductible on your federal income tax return or whether they’re considered capital improvements. Since deductions for capital improvements are typically spread over the life of an asset, the answer can be important even when accelerated depreciation methods are available.
New tax rules can make the expense-or-capitalize decision easier. These “repair regulations” provide guidelines and safe harbors to help you determine when certain purchases and expenditures are considered repairs, maintenance, improvements, materials or supplies that can be deducted in the year of purchase. Here’s an overview of safe harbor rules that may affect the way you classify expenses.
De minimis purchases. In general, you can deduct the cost of tangible property purchased during a taxable year if the amount you pay for the property is less than $500 per invoice, or per item. This is an all-or-nothing rule, meaning if an asset costs more than $500, you cannot take a partial deduction.
To take the deduction, you’ll need a written accounting policy in place by the beginning of your tax year, and you’re required to file an annual statement with your federal tax return.
Note: This safe harbor does not apply to intangible assets such as computer software.
Repairs and maintenance. You can expense costs for routine maintenance of buildings and other property. For buildings, “routine” means maintenance you expect to perform more than once in a ten-year period. The costs for material additions or defects or for adapting your property to a new or different use are not considered routine maintenance, and they should be capitalized.
For other assets, “routine” is defined as maintenance you expect to undertake more than once during the asset’s depreciable class life.
Improvements. Generally, improvements you make to your business building are capitalized and depreciated over the life of the building. Under the new rules, if your business’s gross receipts are $10 million or less and the unadjusted basis of your building is $1 million or less, you may choose to write off the cost of improvements.
You can make the election annually on a building-by-building basis for property you own or lease by filing a statement with your tax return. To qualify, the total amount you pay during the year for repairs, maintenance, and improvements cannot be greater than $10,000 or 2% of the unadjusted basis of the building, whichever is less.
Note: The total includes amounts you deduct under the “repairs and maintenance” and “de minimis” safe harbors.
Materials and supplies. Incidental materials and supplies – supplies for which you do not maintain an inventory – costing less than $200 can be expensed in the year of purchase.
Note: This safe harbor does not affect prior rules for deducting materials and supplies, such as restaurant smallwares.
The repair regulations will affect your federal income tax return. In some cases, you can apply the new rules to prior years. Please contact Cray Kaiser today for additional information.
The tax law provides a valuable tax-saving opportunity to business owners and real estate investors who want to sell property and acquire similar property at about the same time. This tax break is known as a like-kind or tax-deferred exchange. By following certain rules, you can postpone some or all of the tax that would otherwise be due when you sell property at a gain.
A like-kind exchange simply involves swapping assets that are similar in nature. For example, you can trade an old business vehicle for a new one, or you can swap land for a strip mall. However, you can’t swap your vehicle for an apartment building because the properties are not similar. Certain types of assets don’t qualify for a tax-deferred exchange, including inventory, accounts receivable, stocks and bonds, and your personal residence.
Typically, an equal swap is rare; some amount of cash or debt must change hands between two parties to complete an exchange. Cash or other dissimilar property received in an exchange may be taxable.
It is not necessary for the exchange of properties to be simultaneous. However, in the case of such a “deferred” exchange, the replacement property must be specifically identified in writing within 45 days and must be received within 180 days (or by your tax return due date, if earlier), after transfer of the exchange property.
With a real estate exchange, it is unusual to find two parties whose properties are suitable to each other. This isn’t a problem because the rules allow for three-party exchanges. Three-party exchanges require the use of an intermediary. The intermediary coordinates the paperwork and holds your sale proceeds until you find a replacement property. Then he forwards the money to your closing agent to complete the exchange.
When done properly, exchanges let you trade up in value without owing tax on a sale. There’s no limit on the number of times you can exchange property. If you would like to learn more about tax-deferred exchanges, contact us.
*This newsletter is issued quarterly to provide you with an informative summary of current business, financial, and tax planning news and opportunities. Do not apply this general information to your specific situation without additional details and/or professional assistance.
Wedding bells bring rejoicing – and financial changes. If you’re marrying for the second time, the changes might seem overwhelming. On the surface, tax and financial planning for a second marriage is similar to that of a first marriage, but there’s more to taxes and marriage the second time around.
For example, no matter what month you hold the ceremony, the IRS will consider you married for the full year. That means employer-provided fringe benefits and taxes withheld from your paychecks could require adjustment. Depending on how much each of you earns and your past financial history, you’ll have to decide what filing status will be most beneficial, and how best to take advantage of tax breaks that may become available.
With a second marriage, you have even more decisions to make, including how you’ll merge your assets. Will you purchase a new home? If both of you already own separate homes, you may each qualify for a $250,000 federal income tax exemption on the profit from the sale, as long as you have lived in the home for at least two of the last five years. If only one of you meets the requirements for the exemption, consider selling the qualifying home and living in the other for a while.
You or your spouse might also have substantial debt or financial obligations. Discuss your financial histories, including alimony or child support still owed and past bankruptcies. Decide who will provide for the college expenses of the children in your now-combined household. Depending on your age, you may want to investigate the effect of the marriage on your social security benefits.
Consider estate issues too, such as updating retirement plans with new beneficiary designations and retitling bank and brokerage accounts. Be sure to discuss how heirs from previous marriages will be provided for, and remember to update your wills.
A second wedding is a joyful event for you, your new spouse, and your extended families. To give your marriage an added advantage, call us before you say, “I do.” We’ll offer our congratulations – followed by useful financial and tax planning advice.
Don’t wait too long after the wedding to spend a little time on tax matters. Here’s a checklist of things to consider:
If you have questions about taxes and marriage, please contact Cray Kaiser today.
There’s nothing good about being selected for an IRS audit. At best it’s a time consuming nuisance, and at worst you’ll be poorer in the end. But you can reduce your likelihood of being audited, or if you are selected, of being billed.
There are three types of IRS audits. The simplest and most common is a correspondence audit, where the IRS mails you a request for further information about one or more items on your return. In most cases the issues can be resolved by responding with the appropriate documentation.
If you’re selected for an office audit, the IRS will schedule an appointment for you to meet with an auditor at their local facility. They’ll tell you in advance which specific areas of your return(s) will be addressed and what types of documentation you should bring in.
A field audit is more comprehensive. An IRS agent will travel to your home, business, or representative’s office, review the returns at issue, request documentation for questioned items, and ultimately issue a report either recommending a tax change or accepting the returns as filed.
Correspondence audits are often triggered by information matching. The IRS receives W-2s, 1099s, and similar reports from businesses and financial institutions and matches the numbers to the tax returns filed by the individuals involved. If the returns don’t agree with reported figures, the individual will be asked for an explanation and/or simply mailed a bill.
The IRS also uses a computer scoring system to select audits. Based on past experience, the system assigns a score to each tax return indicating the likelihood that the tax was understated or certain income was not reported. Common red flags include the following:
In 2015, above-average audit activity may be expected for upper income individuals, sole business proprietors, partnerships, and S corporations. Cash-intensive enterprises (bars, restaurants, taxis, hair salons, etc.) are particularly apt to receive a higher rate of scrutiny, as are industry categories that tend to have high rates of deductions not independently reported to the IRS (such as construction and real estate rental businesses).
If you do happen to be selected for an audit, call us. We’re prepared to assist you with whatever is needed.
*This newsletter is issued quarterly to provide you with an informative summary of current business, financial, and tax planning news and opportunities. Do not apply this general information to your specific situation without additional details and/or professional assistance.
