Tax Exclusion When You Sell Your Home

February 28, 2007 by Ray Perez.

If you sold your main home, you may be able to exclude up to $250,000 of gain ($500,000 for married taxpayers filing jointly) from your federal tax return. This exclusion is allowed each time that you sell your main home, but generally no more frequently than once every two years.

To qualify for this exclusion of gain, you must meet ownership and use tests.

Ownership Test: During the 5-year period ending on the date of the sale, you must have owned the home for at least 2 years.

Use Test: During the 5-year period ending on the date of the sale, you must have lived in the home as your main home at least 2 years.

If you and your spouse file a joint return for the year of the sale, you can exclude the gain if either of you qualify for the exclusion. But both of you would have to meet the use test to claim the $500,000 maximum amount.

If you do not meet the ownership and use tests, you may be allowed to exclude a reduced maximum amount of the gain realized on the sale of your home if you sold your home due to health, a change in place of employment, or certain unforeseen circumstances. Unforeseen circumstances include, for example, divorce or legal separation, natural or man-made disasters resulting in a casualty to your home, or an involuntary conversion of your home.

If you can exclude all the gain from the sale of your home, you do not report the gain on your federal tax return. If you cannot exclude all the gain from the sale of your home, use Schedule D, Capital Gains and Losses, of the Form 1040 to report it.

Call us for more details and information, or see IRS Publication 523, Selling Your Home.

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Deduction for Educator Expense

February 28, 2007 by Ray Perez.

If you are an eligible educator, you may be able to deduct up to $250 of expenses you paid for purchases of books and classroom supplies. These out-of-pocket expenses may lower your 2006 tax bill even if you don’t itemize your deductions.

• Eligible Educator: The deduction is available if you are an eligible educator in a public or private elementary or secondary school. To be eligible, you must work at least 900 hours during a school year as a teacher, instructor, counselor, principal or aide.
• Qualifying Expenses: You may subtract up to $250 of qualified expenses when figuring your adjusted gross income. Qualified expenses are unreimbursed expenses you paid or incurred for books, supplies, computer equipment (including related software and services) and supplementary materials that you use in the classroom. For courses in health and physical education, expenses for supplies are qualified expenses only if they are related to athletics.

To be deductible, the qualified expenses must be more than the interest on qualified U.S. savings bonds that you excluded from income because you paid qualified higher education expenses, any distribution from a qualified tuition program that you excluded from income, and any tax-free withdrawals from your Coverdell Education savings account.

Call us for more information on Educator Expenses, or see IRS Publication 17, Your Federal Income Tax, under Chapter 19, Education Related Adjustments.

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Which Form of Business Should You Use?

February 26, 2007 by Ray Perez.

Whether you’re starting a new business or expanding an existing one, the choice of a structure for the business can be vital to its success. In this discussion, we’ll briefly describe the forms in which a business can operate, and give you some of the pros and cons of the each form.

Caution: As with any decision involving legal and financial factors, the choice of form for a business should not be made without professional advice.

 

Sole Proprietorship

 

The easiest and least expensive way of starting a business, a sole proprietorship can be formed virtually by opening the business’s doors (or Website). Of course, there will be fees for business name registration, and for any needed licenses. Sole proprietorships are owned by one person, who usually also has day-to-day responsibility for running the business.

TIP: If an owner desires absolute authority over all aspects of the business, the sole proprietorship may be the optimum choice.

Possible Advantages

Sole proprietors own all the assets and all the business profits. In the eyes of the law, the business owner and the business are one and the same. With a sole proprietorship, the tax effects—profits and/or losses—flow directly to the owner’s tax return.

Possible Disadvantages

Sole proprietors have unlimited liability for all debts or claims against the business, and their business and personal assets are at risk. Second, sole proprietorships are often limited to obtaining capital from the owner’s savings, personal assets, or consumer loans. Third, sole proprietorships may not be able to attract high-caliber employees, and also cannot offer employees ownership incentives. Finally, tax-wise, some employee benefits, such as the owner’s medical insurance premiums, do not directly reduce taxable business income.

 

Partnership

 

Partnerships are usually more complicated—and more expensive to set up and maintain—than sole proprietorships.

TIP: Although a general partnership can be formed via a simple oral agreement between at least two people, it is almost always advisable to have a partnership agreement drawn up by an attorney. The partnership agreement sets forth how decisions will be made, profits will be shared, and disputes will be resolved, among other items.

With the partnership, two or more people share ownership of the business. As with the sole proprietorship, the law does not distinguish between the business and its owners.

Note: There are various types of partnerships, including the general partnership (the most common), the limited partnership, and the joint venture. We will not discuss these subcategories here.

Possible Advantages

Partnerships are relatively easy to establish; the legal requirements for a general partnership are much the same as for a sole proprietorship. Another advantage is that a partnership may have more of an ability to raise funds with its multiple owners. As with a sole proprietorship, profits and losses from the business flow directly through to the partners’ personal tax returns. Finally, if the partners are willing to share ownership, prospective employees can be attracted to the business via a partnership incentive.

Possible Disadvantages

One obvious disadvantage is that profits must be shared among the partners. And since decisions must be shared, disagreements can occur. Further, the partners will usually have to invest in the development of a partnership agreement. As for liability, the partners are jointly and individually liable for the actions of the other partners.

TIP: Partnerships, unlike corporations, do not last forever; they expire upon the occurrence of various contingencies. If it is important that your business exist in perpetuity, the corporation is the way to go.

A final disadvantage: Some employee benefits are not deductible from business income on tax returns.

 

Corporation

 

A corporation, which is a legal body chartered by the state in which it is incorporated, is considered by the law to be a separate legal entity, distinct from its owners. A corporation can be taxed; it can sue or be sued; it can enter into contracts. The owners of a corporation are its shareholders. The shareholders elect a board of directors to oversee the major policies and decisions. The corporation does not dissolve when ownership changes or shareholders die.

TIP: Although a business can incorporate without an attorney, legal advice is usually a must for an incorporation.

The corporate structure is more complex and more costly to organize than the other two business forms. Control of the business hinges on stock ownership.

Possible Advantages

For shareholders, liability is generally limited to stock ownership, except where fraud is involved. Officers of a corporation can be liable to stockholders for improper actions.

Note: Officers of a corporation can be held personally liable for certain acts or omissions, e.g., the failure to withhold and pay employment taxes.

As to funding, corporations have the advantage of being able to raise additional funds through the sale of stock. Corporations can deduct the cost of benefits provided to officers and employees.

TIP: Many small businesses are better off electing to be an “S” corporation. This election allows a business to be taxed similar to a partnership, but to maintain corporate status for liability purposes. We won’t cover the separate discussion of S corporations here.

Possible Disadvantages

Incorporation requires more time and money than other forms of business. Further, corporations must meet various formal and recordkeeping requirements—such as holding board meetings and having a corporate charter. Small, closely held corporations can operate somewhat less formally, but record-keeping requirements still must be met.

Corporations are monitored by government agencies, and thus may have more paperwork to complete in order to comply with regulations.

In the tax arena, incorporating may result in higher overall taxes.

 

Limited Liability Company (LLC)

 

LLCs have become the most popular business form for new entities, and many existing entities have converted to this form. They exist in some form in every state. They embody limited liability features of corporations and pass through characteristics of partnerships and S corps, but are more flexible than S corps.

For business law purposes, LLC members may be either passive investors or active investor-managers. Unlike with limited partnerships, active management won’t affect limitation of liability. For federal tax purposes, LLCs are treated as partnerships (unless they elect otherwise).

Note: Since LLC rules vary from state to state, a characteristic, power or rule in the state where an LLC was created may not apply in some other state where it does business.

Note: Some states do, and some states do not, authorize LLCs with only one member.

Tip: Where one becomes the sole surviving LLC member in a state that doesn’t allow single member LLCs, consider quickly incorporating (to regain limited liability) and electing S corp. status (to retain pass through treatment).

*      *      *In conclusion, deciding the form of ownership that best suits your business venture should be given careful consideration. Use of your key advisors is essential to the process.

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Understanding Cash Flow

February 26, 2007 by Ray Perez.

 Failure to properly plan cash flow is one of the leading causes of small business failures. Understanding the basics will help you better manage your cash flow.

Your business’s monetary supply can exist either as cash on hand or in a business checking account available to meet expenses. A sufficient cash flow covers your business by meeting obligations (i.e., paying bills), serving as a cushion in case of emergencies, and providing investment capital.

The Operating Cycle
The operating cycle is the system through which cash flows, from the purchase of inventory through the collection of accounts receivable. It measures the flow of assets into cash.

For example, your operating cycle may begin with both cash and inventory on hand. Typically, additional inventory is purchased on account to guarantee that you will not deplete your stock as sales are made. Your sales will consist of cash sales and accounts receivable credit sales, usually paid 30 days after the original purchase date.

This applies to both the inventory you purchase and the products you sell. When you make payment for inventory, both cash and accounts payable are reduced. Thirty days after the sale of your inventory, receivables are usually collected, increasing your cash. Now your cash has completed its flow through the operating cycle, and the process is ready to begin again.

Current Assets
Cash and other balance-sheet items that convert into cash within 12 months are referred to as current assets. Typical current assets include cash, marketable securities, receivables and prepaid expenses.

Cash-Flow Analysis
Cash-flow analysis should show whether your daily operations generate enough cash to meet your obligations, and how major outflows of cash to pay your obligations relate to major inflows of cash from sales. As a result, you can tell if inflows and outflows from your operation combine to result in a positive cash flow or in a net drain. Any significant changes over time will also appear. Understanding this will lead to better control of your cash flows and will allow adequate time to plan and prepare for the growth of your business.

It is best to have enough cash on hand each month to pay the cash obligations of the following month. A monthly cash-flow projection helps to identify and eliminate deficiencies or surpluses in cash and to compare actual figures to past months. When cash-flow deficiencies are found, business financial plans must be altered to provide more cash. When excess cash is revealed, it might indicate excessive borrowing or idle money that could be invested. The objective is to develop a plan that will provide a well-balanced cash flow.

Planning a Positive Cash Flow
Your business can increase cash reserves in a number of ways.

• Collecting receivables: Actively manage accounts receivable and quickly collect overdue accounts. You stand to lose revenues if your collection policies are not aggressive. The longer your customer’s balance remains unpaid, the less likely it is that you will receive full payment.
• Tightening credit requirements: As credit and terms become more stringent, more customers must pay cash for their purchases, thereby in- creasing the cash on hand and reducing the bad-debt expense. While tightening credit is helpful in the short run, it may not be advantageous in the long run. Looser credit allows more customers the opportunity to purchase your products or services. You should measure, however, any consequent increase in sales against a possible increase in bad-debt expenses.
• Taking out short-term loans: Loans from various financial institutions are often necessary for covering short-term cash-flow problems. Revolving credit lines and equity loans are types of credit used in this situation.
• Increasing your sales: Increased sales would appear to increase cash flow. However, if large portions of your sales are made on credit, when sales increase, your accounts receivable increase, not your cash. Meanwhile, inventory is depleted and must be replaced. Because receivables usually will not be collected until 30 days after sales, a substantial increase in sales can quickly deplete your firm’s cash reserves.

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Tax Return Preparer Fraud

February 22, 2007 by Ray Perez.

Return preparer fraud generally involves the preparation and filing of false income tax returns by preparers who claim inflated personal or business expenses, false deductions, unallowable credits or excessive exemptions on returns prepared for their clients. This includes inflated requests for the special one-time refund of the long-distance telephone tax. Preparers may also manipulate income figures to obtain tax credits, such as the Earned Income Tax Credit, fraudulently.

In some situations, the client (taxpayer) may not have knowledge of the false expenses, deductions, exemptions and/or credits shown on their tax returns. However, when the IRS detects the false return, the taxpayer — not the return preparer — must pay the additional taxes and interest and may be subject to penalties.

The IRS Return Preparer Program focuses on enhancing compliance in the return-preparer community by investigating and referring criminal activity by return preparers to the Department of Justice for prosecution and/or asserting appropriate civil penalties against unscrupulous return preparers.

While most preparers provide excellent service to their clients, the IRS urges taxpayers to be very careful when choosing a tax preparer. Taxpayers should be as careful as they would be in choosing a doctor or a lawyer. It is important to know that even if someone else prepares a tax return, the taxpayer is ultimately responsible for all the information on the tax return.

Helpful Hints When Choosing a Return Preparer

• Be careful with tax preparers who claim they can obtain larger refunds than other preparers.
• Avoid preparers who base their fee on a percentage of the amount of the refund.
• Stay away from preparers who claim that many, if not most, phone customers can get hundreds of dollars or more back under the telephone tax refund program.
• Use a reputable tax professional who signs your tax return and provides you with a copy for your records.
• Consider whether the individual or firm will be around to answer questions about the preparation of your tax return months, or even years, after the return has been filed.
• Review your return before you sign it and ask questions on entries you don’t understand.
• No matter who prepares your tax return, you (the taxpayer) are ultimately responsible for all of the information on your tax return. Therefore, never sign a blank tax form.
• Find out the person’s credentials. Only attorneys, CPAs and enrolled agents can represent taxpayers before the IRS in all matters including audits, collection and appeals. Other return preparers may only represent taxpayers for audits of returns they actually prepared.
• Find out if the preparer is affiliated with a professional organization that provides its members with continuing education and resources and holds them to a code of ethics.
• Ask questions. Do you know anyone who has used the tax professional? Were they satisfied with the service they received?

Reputable preparers will ask to see your receipts and will ask you multiple questions to determine your qualifications for expenses, deductions and other items. By doing so, they are trying to help you avoid penalties, interest or additional taxes that could result from an IRS examination.  

Further, tax evasion is a risky crime, a felony, punishable by five years imprisonment and a $250,000 fine.

Criminal Investigation Statistical Information on Return Preparer Fraud

*Incarceration may include prison time, home confinement, electronic monitoring or a combination.

Criminal and Civil Legal Actions

Some return preparers have been convicted of, or have pleaded guilty to, felony charges.

Additionally, the courts have issued 175 permanent injunctions against abusive tax scheme promoters and abusive return preparers since 2003. The following case summaries are excerpts from public record documents on file in the court records in the judicial district in which the legal actions were filed.

California Tax Preparers Sentenced to Prison Terms for Operating Tax Fraud Schemes

On Oct. 6, 2006, in San Diego, Calif., Susan E. O’Brien, a professional tax preparer who operated “The O’Brien Group,” was sentenced to ten years and five months in prison and ordered to pay $113,179 in restitution. She was convicted on May 2, 2006, for tax evasion, defrauding the United States and aiding and assisting in the filing of fraudulent tax returns. Co-defendants Robert Richard Evans and William Dean Cook were also sentenced to prison terms of 78 and 24 months, respectively. In July 2003, O’Brien, Evans, Cook and five others were charged in a 78 count indictment with various tax crimes related to tax years 1996-2002. According to the indictment and trial evidence, O’Brien prepared numerous income tax returns that claimed false business deductions and Evans promoted, sold and managed domestic trusts used by clients to hide their income and assets from the IRS. O’Brien also was convicted of evading the payment of tax on her own income. The tax evasion scheme resulted in a tax loss to the United States  of more than $1 million.

Two Sentenced for Preparing False Tax Returns

On Sept. 20, 2006, in Monroe, La., Eddie Ferrand and William Kennedy were sentenced for aiding and assisting in the preparation of false income tax returns and conspiracy. Ferrand was sentenced to 60 months in prison to be followed by three years supervised release. Ferrand was also ordered to pay $255,890 in restitution to the IRS and a $900 assessment. Kennedy was sentenced to 27 months in prison to be followed by three years supervised release. Kennedy was also ordered to pay $39,020 in restitution to the IRS and an $800 assessment. According to the indictment, Ferrand, as the owner and operator of Mr. Ed’s Tax Service, hired, trained and supervised tax preparers employed at Mr. Ed’s, including co-defendant Kennedy. Ferrand, Kennedy and other co-defendants prepared income tax returns and amended prior year returns by inflating Schedule A deductions and creating false Schedule C businesses in order to increase taxpayer’s refund. The defendants prepared more than three thousand returns expanding over 26 states and generating refunds in excess of $6 million.

Minnesota Tax Preparer Sentenced for Filing False Tax Returns

On March 23, 2006, in Minneapolis, Minn., Richard Reiss was sentenced to 41 months in prison for aiding and assisting in the preparation of 84 false tax returns. Reiss was also ordered to pay a $7,500 criminal fine and $198,958 in back taxes. Reiss prepared tax returns for more than 30 clients and claimed fraudulent and false deductions such as unreimbursed employee business expenses, mileage expenses, meals and entertainment, charitable contributions, medical expenses and tax preparation fees, and business losses resulting from business expenses that were fabricated or inflated. In total, he overstated expenses and deductions for numerous clients by more than $1 million, which resulted in tax losses of about $198,000.

Tax Preparer Who Used Bogus Business Losses to Wipe Out Clients’ Income Taxes Sentenced to 11 Years in Prison

On Feb. 21, 2006, in Los Angeles, Calif., James Earl Wynn was sentenced to 11 years in federal prison following his April 22, 2005 conviction of 24 counts of aiding and advising in the preparation of false income tax returns. Evidence presented in court showed that Wynn solicited his clients by telling them that he operated a number of businesses in which they could invest. Wynn told his clients that if the businesses turned a loss, the clients could claim the loss on their tax return. As part of this arrangement, Wynn offered to prepare the clients’ tax returns charging his clients a percentage of their tax refunds in addition to a return preparation fee. Wynn did not tell his clients that many of the businesses listed on their tax returns did not exist at all. None of the businesses listed on their tax returns as part of the tax fraud scheme ever existed as a partnership, ever filed a partnership tax return or ever sustained the losses claimed on the taxpayers’ returns. Wynn caused more than 2,000 tax returns to be filed with the IRS claiming more than $75 million in false partnership losses. The tax loss to the government exceeded $10 million. On July 18, 2005, Linda M. Hall, who once worked for Wynn, was sentenced to 70 months imprisonment and was ordered to pay restitution of $6,339,023.

Rockford Tax Preparer Sentenced to 56 Months in Federal Prison for Preparing False Tax Returns

On Feb. 13, 2006, in Rockford, Ill., John H. Bell was sentenced to 56 months in prison, followed by one year supervised release, for preparing false federal income tax returns for others and for filing a false federal income tax return for himself. According to the indictment, Bell, the owner of Bell’s Income Tax Service and of Real Estate Investors (REI) #2462, Inc., prepared false income tax returns for others. In order to support the returns, Bell attached W-2s to the returns that falsely stated the amounts of income the taxpayers received from REI and falsely stated the REI had withheld federal income tax from the taxpayers when, in fact, no such taxes had been withheld by Bell or his corporation. The indictment also charged that Bell filed an income tax return for himself that falsely stated that $8,360 in federal income tax had been withheld from him, when no federal income tax had been withheld by REI. As a result of his own false return, Bell wrongfully attempted to obtain a refund of $8,701.

Former City of Houston Employee Sentenced to Prison

On Jan. 27, 2006, in Houston, Tex., Jerome Harris was sentenced to 57 months in prison followed by one year supervised release. The judge further ordered that, effective immediately, Harris be prohibited from preparing tax returns or assisting tax payers in audits. Harris was convicted of 21 counts of willfully preparing fraudulent income tax returns for his clients in September 2005. Harris, a full time employee for the City of Houston, also owned and operated Jay’s Bookkeeping and Tax Service, located at his residence. It was found that Harris had prepared hundreds of false tax returns for the 1995 through 2000 tax years, resulting in claims for fraudulent tax refunds by his clients totaling almost $1.3 million.

Michigan Man Sentenced For Preparing Tax Returns in Violation of Court Order

On Feb. 16, 2006, in Grand Rapids, Mich., Robert L. Mosher, of Cedar Springs, Mich., was sentenced to 105 days in prison for contempt of court after violating injunctions that barred him from preparing tax returns for customers. Two injunctions were obtained after the Justice Department sued Mosher in 2003 for promoting a tax scheme involving sham trusts and preparing fraudulent returns understating customers’ tax liabilities. Mosher continued to prepare income tax returns after these orders were entered.

Federal Court Permanently Shuts Down Louisiana Tax Preparer

On April 18, 2006, Eddie Ferrand of Monroe, La., and two of his employees, Glenda Faye Elliott of Monroe, La., and William Nathaniel Kennedy of Rayville, La., were permanently barred from preparing tax returns. The court found that Ferrand, Elliott and Kennedy regularly understated customers’ tax liabilities, by claiming false dependents, reporting fictitious business expenses and deductions and inflating other deductions.

Federal Judge Stops Tax Refund Fraud by Two Florida Tax Return Preparers

On Aug. 8, 2006, a federal court permanently barred Jean-Marie Boucicaut and Marie Thelemarque of Orlando, Fla., and Boucicaut’s company, Tax Review Corporation, from preparing federal tax returns for others. The court found that the defendants filed amended income tax returns for persons without their authorization and directed the IRS to send the requested refund checks to them.

Federal Court Bars Louisiana Tax Preparers from Claiming Inflated Deductions on Income Tax ReturnsOn Oct. 5, 2006, in New Orleans, La., Rodney G. Bourg and Cynthia M. Bourg of Houma, La., were permanently barred from preparing federal income tax returns claiming inflated deductions or asserting unrealistic positions. The court found the Bourgs prepared federal income tax returns with improper per diem expense deductions for customers who worked as mariners, fishermen, merchant seamen and ferry workers.

Where Do You Report Suspected Tax Fraud Activity?

If you suspect tax fraud or know of an abusive return preparer, report this activity using IRS Form 3949-A, Information Referral. You can download Form 3949-A from this Web site or call 1-800-829-3676 to order by mail. Send the completed form, or a letter detailing the alleged fraudulent activity, to Internal Revenue Service, Fresno, CA 93888. Please include specific information about who you are reporting, the activity you are reporting and how you became aware of it, when the alleged violation took place, the amount of money involved and any other information that might be helpful to an investigation. Although you are not required to identify yourself, it is helpful to do so. Your identity can be kept confidential. You may also be entitled to a reward.

FS-2007-12, January 2007

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Guidelines for Roth IRA Contributions

February 22, 2007 by Ray Perez.

Taxpayers confused about whether they can contribute to a Roth IRA should consider guidelines based on the following categories:

• Income Limits To contribute to a Roth IRA: You must have compensation (e.g., wages, salary, tips, professional fees, bonuses). These limits vary depending on your filing and marital statuses.
• Age: There is no age limitation for Roth IRA contributions.
• Contribution Limits In general: If your only IRA is a Roth IRA, the maximum 2006 contribution limit is the lesser of your taxable compensation or $4,000 ($4,500 if 50 or older). The maximum contribution limit phases out depending on your modified adjusted gross income.
• Spousal Roth IRA: You can make contributions to a Roth IRA for your spouse provided you meet the income requirements.
• Time Contributions to a Roth IRA can be made at any time during the year or by the due date of your return for that year (not including extensions).

Roth IRA contributions are not tax deductible and are not reported on your tax return. On the other hand, you do not include in your gross income, and therefore are not taxed on, any qualified distributions or distributions that are a return of your regular Roth IRA contributions or that are rolled over into another Roth IRA.

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Home Office Deduction

February 21, 2007 by Ray Perez.

If you use a portion of your home for business purposes, you may be able to take a home office deduction whether you are self-employed or an employee. Expenses that you may be able to deduct for business use of the home may include the business portion of real estate taxes, mortgage interest, rent, utilities, insurance, depreciation, painting and repairs.

You can claim this deduction for the business use of a part of your home only if you use that part of your home regularly and exclusively:

• As your principal place of business for any trade or business.
• As a place to meet or deal with your patients, clients or customers in the normal course of your trade or business.
• Generally, the amount you can deduct depends on the percentage of your home that you used for business. Your deduction will be limited if your gross income from your business is less than your total business expenses.
• If you use a separate structure not attached to your home for an exclusive and regular part of your business, you can deduct expenses related to it.
• If you are self-employed, use Form 8829 to figure your home office deduction and report those deductions on line 30 of Schedule C, Form 1040. There are special rules for qualified daycare providers and for persons storing business inventory or product samples.
• If you are an employee, you have additional requirements to meet. The regular and exclusive business use must be for the convenience of your employer.

For more information, or see IRS Publication 587, Business Use of Your Home.

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Be Careful When Making Loans To A Related Party

February 21, 2007 by Ray Perez.

If you lend money to your closely held corporation or to a member of your family, be sure to handle the transaction with all of the formalities of an “arm’s-length” loan to a stranger. The IRS carefully scrutinizes loans where the lender and the borrower are “related.”

In the case of a “loan” to a family member, the IRS often claims that the purported loan was actually a gift and there was never any intention that it would be repaid. It will therefore generally challenge a claimed bad-debt deduction when such a “loan” goes bad.

In the case of a “loan” by a shareholder to his or her corporation, the IRS frequently takes the position that the money advanced was actually an additional capital investment—stock rather than true debt. If the IRS does accept the loan as valid, it may tax the shareholder on the difference between current arms-length interest rates and any lesser interest actually charged.

That’s why the formalities are so important in making a loan to a related party.

TIP: Here are some of the things you might do to try to insulate a related-party loan against IRS attack: •  Evidence the loan with a note (avoid open account or handshake deals). •  Provide for a fair rate of interest and have it paid regularly. •  Provide for security (if possible). •  Set a maturity date. •  Spell out when repayments are to be made and have them made in accordance with these terms.

In the case of a loan to a closely held corporation, there are certain other tax factors that should be considered, for example, whether the ratio of loans to stock is “excessive.” Where the ratio is excessive, the corporation may be denied a deduction for interest paid on the loan (in addition to the risk that the loan will be treated as an additional capital investment).

TIP: In brief, you must show that both parties intended to create a bona fide debtor-creditor relationship. And if the loan goes bad, you must establish that all of the steps necessary to enforce collection were taken.

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Now You Can Split Your Refund Among Three Accounts

February 19, 2007 by Ray Perez.

You have more options and flexibility for receiving your 2006 federal income tax refund.

Now you can:

• Split your refund with direct deposits into two or three checking or savings accounts
• Direct deposit your refund into one checking or savings account
• Receive your refund as a paper check in the mail

Splitting your refund is easy. Use IRS’ Form 8888, Direct Deposit of Refund to More Than One Account, to divide your refund among two or three different accounts. If you want IRS to deposit your refund into one account, you can use the direct deposit line on your tax form.

With split refunds, you have a convenient option for managing your money — sending some of your refund to an account for immediate use and some for future savings — teamed with the speed and safety of direct deposit.

Whether you file electronically or on paper, direct deposit gives you faster access to your refund than a paper check. Speed, safety and choice — with direct deposit you can have it all.

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Selling Your Home: What You Need To Know Tax-Wise

February 19, 2007 by Ray Perez.

If you sell your main home, you will probably be able to exclude all or part of any profit you make on the sale for federal income tax purposes. Thus, if you qualify, you will not have to pay tax on the profit, up to the limit discussed below. To qualify, you must meet the “ownership” and “use” tests described here.

Amount of Exclusion

• $250,000, or
• $500,000, if all of the following apply: (1) you are married and file jointly for the year, (2) either you or your spouse meets the ownership test, (3) both you and your spouse meet the use test, and (4) neither you nor your spouse excluded gain from the sale of another home in the two-year period before sale.

Ownership and Use Tests

You can claim the exclusion if, during the five-year period ending on the date of sale, you have:

• Owned the home for at least two years (the ownership test), and
• Lived in the home as your main home for at least two years (the “use” test).

The two years of ownership and use during the five-year period don’t have to be continuous. You meet the tests if you can show that you owned and lived in the property as your main home for either 24 full months or 730 days during the five-year period. Short temporary absences, such as vacations, are counted as periods of use, even if you rent out the property during that time.

Ownership and Use Tests Met at Different Times. You can meet the ownership and use tests during different two-year periods. However, you must meet both tests during the five-year period ending on the date of the sale.

Special Situations. There are a number of special situations that may result in exceptions to the general rules. For instance, there is an exception to the 2-out-of-5-year use test if you become physically or mentally unable to care for yourself at any time during the five-year period. You qualify for this exception to the use test if, during the five-year period before the sale of your home:

• You become physically or mentally unable to care for yourself, and
• You owned and lived in your home as a main home for a total of at least one year.

Under this exception, you are considered to live in your home during any time that you live in a licensed facility such as a nursing home.

Caution: There are other special rules and complexities involved with the exclusion, making it all the more important to consult with your tax advisor before entering into a sale transaction.

More Than One Home Sold During the Two-Year Period

You cannot exclude gain on the sale of your home if, during the two-year period ending on the date of the sale, you sold another home at a gain and are excluding all or part of that gain.

However, you can claim a reduced exclusion if you sold the home due to a change in health or place of employment.

Business Use

You cannot exclude the part of your gain that is equal to any depreciation taken for the business use of your home after May 6, 1997.

Where No, or Partial, Exclusion

Gain that doesn’t qualify for exclusion—including gain in excess of the exclusion amount, is capital gain. This, with some exceptions, is true of gain allocable to depreciation.

Caution: Loss on sale of your home is not deductible.

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