Janell Israel and Associates May June Newsletter

Janell A. Israel & Associates

1585 Kapiolani Blvd., Suite 1604, Honolulu, Hawaii 96814 Phone: 808-942-8817

May/June 2010 Tax Newsletter

What's new in taxes:

Taxes And Your Child's Summer Job

Is your child looking for a job this summer? If so, you both may have questions about taxes. Here are three common concerns.

* Is a tax return required? The answer depends on several factors, including the total amount of income received. For instance, if wages are the only source of income, your child can generally earn up to $5,700 during 2010 before a federal tax return is necessary.

However, unless your child can claim an exemption from withholding, a return may be required even when wages earned are lower than the filing requirement. That's because filing is the only way to claim a refund of overpaid taxes.

In addition, self-employment income, tips, and interest, dividends, and stock sales can affect the filing requirement.

* Can my child open an IRA? Anyone under age 70½ who has earned income can contribute to a traditional IRA. There's no age restriction for Roth accounts, though the amount of the contribution phases out at higher income levels (starting at $105,000 for single individuals in 2010).

If your child will receive a federal income tax refund, you could choose to have it deposited directly into an IRA account. As an alternative, you can provide the funds for an IRA and let your child keep the refund. The maximum standard contribution for 2010 is $5,000.

* Are there any tax breaks if my child works for me? You can take a business tax deduction when you pay a reasonable wage for work your child performs in your business. If your business is a sole proprietorship or a partnership you and your spouse operate, and your child is under age 18, you don't have to pay social security, Medicare, or federal unemployment taxes. The child's wages are subject to income taxes.

If you have other questions about the tax implications of a summer job, give us a call.

IRS to Focus Audit Activity In These Areas

The IRS has announced its audit plans, which includes audits in the following three areas:

* A three-year random audit program started by the IRS in 2007 will now be continued indefinitely. These random audits of individual income tax returns are used by the IRS to collect noncompliance data for adjusting general audit formulas and updating tax gap estimates.

* Another audit target: tax returns claiming the homebuyer tax credit. The IRS expects to open 200,000 audits by the end of 2010 to address potential fraud in claiming this credit. The Service will also be watching the recapture of the credit via public databases of real estate sales. Generally, those who sell a home within three years of taking the tax credit must pay it back.

* According to IRS Commissioner Douglas Shulman, the Service is planning to focus significant audit resources on individuals with millions of dollars in assets or income, including the business entities controlled by these high-income taxpayers.

Don't overlook state taxes in your tax planning

To keep more of what you make, tax planning at both the state and federal level is essential. Even if you live in an income tax-free state, you may not be able to escape state taxes entirely. Here are some common examples of when you need to pay attention to state tax planning.

* If you own property in another state, you need to be aware of how that state's income taxes and estate taxes will affect you.

* If you have college-bound children, you're probably familiar with tax-advantaged Section 529 college savings plans. Most states offer a Section 529 college savings plan to both residents and nonresidents. While the federal income tax rules are the same for all plans, state tax rules vary.

* If you buy goods from out of state, you may be subject to use tax in your home state. Use tax is the equivalent of sales tax that retailers charge. If you didn't pay sales tax at the source, you may be required to report the purchase to your own state department of revenue along with the appropriate taxes owed.

* If you own a business and advertise in another state, you might be considered to be doing business in that state. This is called nexus. There could be state income tax and sales tax implications.

* If you split the year living in more than one state, you may owe state taxes in each state. Many states require part-year residents to pay state income taxes on some of their income.

* Stay informed about state estate tax changes. Changes to the federal estate tax rules have cost states billions of dollars in lost tax revenue. As a result, many states have changed their estate tax laws to make up for the shortfall.

* Finally, don't assume that because income is tax-free for federal income tax purposes, it is free from state income tax. States individually decide how closely the state tax rules will follow the federal rules.

For assistance with all your tax planning needs, please call us.

New Business:

IRS Alerts Businesses To Tax Benefits

The "HIRE Act," passed in March, provides tax incentives for companies to hire unemployed workers. One of these incentives is an exemption from social security payroll taxes for every qualified worker hired after February 3, 2010, and before January 1, 2011.

A new IRS form is now available for employers to document this payroll tax exemption for hiring unemployed workers. Form W-11 (Hiring Incentives to Restore Employment Act Employee Affidavit) is to be filled out by the new hire, certifying under penalty of perjury that he or she was either unemployed or worked fewer than a total of 40 hours during the 60 days prior to taking the current job. The W-11 forms are not filed with the IRS; the employer must retain them along with other payroll records.

The recent health care reform legislation included a new health care tax credit for certain small businesses that provide health insurance to their employees. The IRS is in the process of mailing postcards to more than four million small businesses and tax-exempt organizations to make them aware of this new credit for 2010.

The credit is generally available to small companies and tax-exempt organizations that pay at least 50% of the cost of single coverage for their employees. For tax years 2010 to 2013, the maximum credit is 35% of premiums paid by eligible employers (25% for tax-exempts).

Should Your Business Operate As an LLC?

You've beaten the odds. Your business has succeeded and your profits are growing. But you struggle with the uncertainty of whether you are operating under the right legal form. Should you incorporate? Form a partnership? Perhaps you should consider a form of business that has become very popular: the LLC.

Limited liability companies (LLCs) offer a flexible alternative to partnership and corporate legal forms. While partnerships provide a seamless pass-through of income and losses to partners, they offer little protection of personal assets from creditors. Corporations, on the other hand, provide asset protection, but income can be taxed at both the corporate and individual levels. LLCs make available the best of both worlds: asset protection with pass-through of income and losses directly to the owners.

LLCs are not the only form of business to allow this. S corporations are used by small, closely held entities to achieve the same goals. But LLCs are preferred under certain conditions. For example, income and losses in an LLC can be allocated to members disproportionately, thereby allowing for different ownership classes. S corporation income must be allocated to members based on ownership percentage. Also, unlike S corporations, LLC members can be individuals, trusts, or any other type of entity. This may provide more options in estate planning.

In the real estate industry, LLCs often get the nod over S corporations because it may be easier to increase basis and allow for the deduction of losses.

Deciding on a legal form for your business is not easy. Each form has its advantages and disadvantages. The best first step is to sit down with your tax and legal advisors and share your goals. The proper form of business can be the launching pad you need to reach the next level of success. For details or assistance, give us a call.

What's New in Finances

Two Prior IRA Rules Are Still In Effect For 2010

Rule #1. Note that while converting a traditional IRA to a Roth IRA is now open to everyone, regardless of income, contributing to a Roth IRA is still not allowed for higher-income taxpayers. For 2010, Roth IRA eligibility phases out for singles once income reaches $105,000 and for joint filers once income reaches $167,000.

Rule #2. For 2010, annual minimum distributions from most retirement plans (except for Roth IRAs) are once again required for those aged 70½ and older. In 2009, these required minimum distributions (RMDs) were suspended. 2010 required distributions must be taken by December 31, 2010. Taxpayers who turn 70½ in 2010 may choose to delay taking their first distribution until April 1, 2011.

For additional information or assistance with your IRA decisions, give us a call.

The Big 2010 Question: To Roth Or Not?

For the first time ever, high-income taxpayers are eligible to convert a traditional IRA to a Roth IRA. Prior to 2010, you could not convert to a Roth in a year in which your modified adjusted gross income exceeded $100,000. But this limit was removed by a 2006 tax law change that took effect January 1, 2010. So the question of the year is, should you do a conversion? There are numerous factors to take into account.

First, you must understand the critical differences between the two IRAs. With a traditional IRA, contributions may be partially or wholly tax-deductible, but distributions are generally taxable at ordinary income rates. In contrast, contributions to a Roth IRA are never tax-deductible, but qualified distributions from a Roth in existence at least five years are completely exempt from tax. Qualified distributions are those made after age 59½, due to death or disability, or used for first-time homebuyer expenses (lifetime limit of $10,000). Also, unlike a traditional IRA, mandatory distributions after age 70½ aren't required for a Roth.

Thus, by converting to a Roth, you pay an up-front tax on the current value of IRA assets in exchange for future tax-free withdrawals. For a conversion occurring in 2010, you can choose to split the taxable income evenly over the following two years, 2011 and 2012.

In analyzing whether you should convert or not, consider the following points:

* If you have to pay all or part of the conversion tax with funds in your traditional IRA, the benefit of the conversion is diluted. The account can grow even larger if you have other resources to pay the required tax.

* Consider state income tax implications. In some situations, the combination of federal and state income tax liability could discourage a conversion.

* Both your current income tax rate and your projected income tax rate can affect your decision. For instance, if you're now in a high tax bracket but expect to be in a much lower bracket in retirement, you may be less inclined to convert from a traditional IRA. Conversely, the prospect of rising tax rates generally favor a Roth conversion.

* Spreading out the tax liability for a 2010 conversion over the next two years may not be the right choice in your situation.

* Converting to a Roth could trigger alternative minimum tax (AMT) liability.

* Be aware that you don't have to convert the entire balance in an IRA or all your IRAs. Partial conversions are permitted. Finally, you have the ability to "recharacterize" a Roth back into a traditional IRA if it suits your needs.

Call us if you would like to discuss the suitability of a Roth conversion in your personal situation.

Working after retirement could affect your benefits and your taxes

People often work beyond the "normal" retirement age. Here's how extending your work life can affect your taxes and retirement benefits.

"Normal" retirement age is not a fixed number. For social security purposes, the "full" retirement age threshold ranges from 65 to 67, depending on your birth date. However, you can elect to start receiving lower payments as early as age 62, or you can maximize your benefits by forgoing them until you're 70. Once you reach age 70, there's no incentive to postpone your benefits further, since you'll already have reached your maximum.

* Earnings limit. If you're working, you probably should forgo the early payment option. Benefits received before full retirement age will be reduced by $1 for every $2 earned over an annual limit (currently $14,160). However, you will receive a compensating increase when you do reach full retirement age, and your payments will not be reduced thereafter no matter how much you earn.

* Taxable benefits. Whether or not you draw benefits, you'll continue to pay social security and Medicare taxes on any income you earn from wages or self-employment. Up to 85% of your benefits may become subject to income tax, depending on the amount of your other income.

* Medicare. Medicare eligibility begins the year you reach age 65. The program encompasses four types of coverage: Medicare A (hospital insurance), Medicare B (general medical insurance), Medicare C (Medicare Advantage), and Medicare D (prescription drug coverage).

It's wise to sign up for Medicare A as soon as you're eligible. There's no cost, and the program provides supplemental coverage even if you're already insured at work. Medicare B and D are neither free nor mandatory, but the monthly premiums are reasonable, and either may be used as a stand-alone program or in conjunction with a private plan. If you have "creditable coverage" at work (i.e., coverage that's at least as good as Medicare), you can postpone signing up for Medicare B and/or D until you're no longer employed.

Your employer's plan also may offer Medicare C, which provides for private programs administered under contract with the government. These plans typically merge Medicare A and B benefits with other coverage.

Working beyond retirement age can require several complex decisions. Call us for help with planning the outcome that's best for you.

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