December 1991
Vol 15 No 2
Your government (Federal, State and local) is BROKE! Like Jimmy Durante used to say, 'Everyone's trying to get into the act.' I'm sending this newsletter out early this month to give you time to make some tax-preventive adjustments before it's too late. Hopefully, you took my advice in other years and did some forward planning so that this year didn't catch you by surprise. And, once again I'll remind you that your tax planning should include 1992 as well as 1991 if you expect to OPTIMIZE your tax bill.
Let's look at some of the tax changes currently in the legislative hopper. It's doubtful that any of these will be enacted before 1992, but as long as Congress is in session, anything can happen. I wonder whose lips we'll read in 1992.
1. Capital gains tax reduction – this won't pass without some other revenue raising counter measures, possibly in the estate tax or sales tax area.
2. Estate/gift tax – possible reduction in the Unified Credit which will drop the life time gift exclusion from the present $600,000 to $175,000.
3. National sales tax or value-added tax (VAT) to broaden the tax base.
4. Increases in 'sin' taxes on alcohol and tobacco.
5. Additional excise taxes on luxury cars, jewelry, RVs, boats.
6. Higher gasoline and fuel oil taxes.
7. Hikes in self employment and unemployment taxes plus workman's compensation costs.
8. A new approach to IRAs which will provide for wider participation.
9. Alternate minimum tax (AMT) base broadening to include more income.
We can expect to see increases in Impact Fees, Ad Valorem Tax millage rates, more states adopting State Income Tax (and some cities too), Corporate Income Taxes, Business and Franchise Taxes, Usage Taxes. Costs of licenses and fees will also rise. Don't be surprised to see basic tax rates climb under the guise of tax 'simplification'.
BIG BROTHER IS WATCHING YOU MORE THAN EVER . . .
State and Local government are cooperating with the feds to throw a net over all the available income they can. They're using a national computer network called 'TaxExchange', a national wage reporting system, a uniform information exchange agreement, and a centralized cross indexing system to collect sales taxes from businesses that are selling in more than one state. They've even gotten the Supreme Court to take another look at allowing States to collect sales taxes on all catalogue sales (newsletters) sold through the mails. It looks as if George Orwell might have been right on target in 1992.
Document matching, a perennial favorite and major income producer for the IRS, will be screwed down tighter. Early detection software is already in place to detect erroneous social security and employer identification numbers. Where deductions can't be matched with corresponding 1099s submitted by mortgagees, they'll be disallowed. Ditto for exemptions for kids and spouses who don't have social security numbers.
SOME SPECIAL TAX BREAKS WILL EXPIRE ON DECEMBER 31st THIS YEAR!
Educational Assistance Exclusion which allows you to exclude $5250 per year of money provided to an employee for NON-JOB RELATED tuition, fees, books, supplies, etc. under an employer's educational assistance program (Code Sec. 127) must be spent in 1991, even if you don't actually attend classes until 1992. (Please Note the 1991/1992 schedule at the end of this letter, just in case you want to deduct seminar fees.
Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com. (888) 282-1882
Quotation not permitted. Material may not be reproduced in whole or part in any form whatsoever.
Tax Credits for Low Income Housing, R&D, Jobs will all be axed this year. So will the 25% deduction for self-employed people and S-Corporation owners' Health Insurance. Better get those paid in 1991 too. Mortgage Subsidy Bonds are also on the chopping block. All of these expiring breaks will affect the amount of money available for business and investment in the affected market sectors. If you're planning to find financing in low income housing or with mortgage bonds, do it quickly or not at all.
Lots of deductions are also being phased out for high income earners and some of the personal exemptions/deductions are being indexed upward. Here's a quick review:
1. Personal Exemptions: $2150 for 1991, $2300 for 1992.
2. For marrieds: Standard Deductions: $5700 for 1991, $6000 for 1992 for marrieds, plus:
3. Each spouse 65 and over gets an additional $650 in 1991 and $700 in 1992.
4. For singles: $3400 (+ $850 if over 65) in 1991, $3600 (+ $900 if over 65) in 1992.
5. Deductions for charitable contributions, taxes, mortgage interest, miscellaneous items are cut by 3% of adjusted gross income over $100,000. ($105,250 in 1992). That's equal to $1500 at an income of $150,000. And as income rises above $100,000, you also start to lose part of your $25,000 deductions for active rental management. Remember, if you sell, or are foreclosed out of a property with mortgage over basis, it could drive your income into the $100,000+ range.
6. With all the phaseouts; itemized deduction floors above AGI for medical expenses (7.5), casualty losses (10%), and miscellaneous itemized deductions (2%) respectively will effectively be lost as income rises.
7. Personal Exemptions will also be slashed by 2% for each $2500 of AGI above $150,000 for couples. $100,000 for singles. This effectively increases the top tax bracket.
8. Social security wage base and medicare wage bases will rise from $53,400 and $125,000 in 1991 to $55,500 and $130,200 in 1992. This will have a big impact upon decisions many people will make as to whether to retire earlier or later.
9. Capital gains remain at 28% nominally, but they're added to your ordinary income to effectively drive you into the 31% bracket, so you have to also watch sales. The good thing about gains taxes is that YOU control the timing of receipt of taxable gain. You can elect installment sale treatment, spreading the tax payments out over several tax years. And by using Section 1031 and 1034 (or Sec 121 one-time residence sale for the over 55 year olds) Tax Free Exchanges, you can defer taxes until a more favorable tax period.
TIMING OF RECEIPTS AND PAYMENTS IS THE KEY TO OPTIMIZING YOUR TAX COSTS . . .
Its usually more difficult to control the timing of receipt of employment income than it is to adjust the timing of payment of expenses. Most employers have a set scheme of payments which meets their operating needs. You might attempt to arrange some flexibility over year-end bonuses. Merely refusing to accept them until the next year won't work, since the IRS will say that you've had constructive receipt of them anytime that you were ENTITLED to payment under the terms of your employment arrangement. You might work out a bonus to be paid the FIRST WEEK of the new year rather than the LAST WEEK of the old year. This would give you a 15 month delay in the payment of taxes on that amount. If you needed the money sooner, you might borrow in December, repay in January, using your bonus as security for a signature loan.
Income from rentals can be handled a little more flexibly. One of the tenant's options in our rental contract is to skip the December payment entirely after payment of 10% per month extra for 10 months. This increases our cash flow while holding the tenant to the property. If he leaves, he doesn't get the benefit of the free December rent. But that just makes things worse if we've got too much income.
Another approach used by one subscriber is to let the tenant skip the December payment and pay a double payment on January 1st. He only uses this with tenants who have an outstanding payment record and who have large deposits with him. This effectively moves one month's rent into the next following year. He ties this in with MULTI-YEAR LEASES as a rent incentive for BUSINESS REASONS.
Rents due on December 31st are rarely paid on time because few tenants view NEW YEARS EVE as a rent day. And most of the places where money orders can be bought aren't open. So by having rents due the last day of the year AND OVERDUE THE 3RD OF EACH MONTH, an automatic bias is built in for 'next year payment' and tax deferral.
We typically roll our rentals over on January 31st, thus new money coming in is taxed and paid in the following year. By knowing in advance how much net rental income we are getting, we can add to our passive activity portfolio and use it to shelter the income. Schedule as many closings as possible for the month of January. Use Lease Options as timing devices which enable the buyers to occupy the premises, but to defer closing the deal until January. This gives them a chance to 'try out' the property before actually buying it, and reduces the complaints to us. In some cases, it also gives them a chance to do the fix up and repairs as a part of their down payment. Another bonafide BUSINESS reason. All tax strategies must be based upon business rather than tax motives.
Anytime that you carry installment paper back on a sale, you can elect to declare the transaction the same as cash and incur taxes on it. This is a good idea when you have passive losses carried forward which you would otherwise waste. Suppose you had $25,000 in unusable passive losses accrued from this and prior years and could match that up with a Note which represented a $25,000 net gain. They would offset each other, simplifying your bookkeeping and tax reporting. And the future payments of principal would all come in tax free. Since your taxable basis in the note would now be $25,000, you could also use it in subsequent transactions as partial payment on another house, transferring your $25,000 to that house. When you subsequently sold it, you'd still get the $25,000 out tax free.
Planning expenses to lower your taxes makes a lot of sense. Each year during the early part of December we survey our rental properties and plan year-end maintenance. Initially, emphasis is placed upon curb appeal, landscaping, painting, down spouts and gutters, tree trimming, fences, screens, doors, windows, swimming pools, etc. In Florida, it's usually still mild enough to do outside repairs comfortably. Then we start on the heating systems, plumbing fixtures, appliances, painting and floor coverings, window treatments. We budget expenses for each property and contract to have repairs done as soon as possible.
By prepaying these contracts just ahead of the Christmas season, during what is usually a slow period for workman, we can get better prices and quicker response to our requirements. This enables us to do a final 'trimming' of our estimated tax bill so as to squeeze out the last possible deduction just before year end. Even if we had to borrow the money with which to pay the contractors, we'd still get the deductions for the repairs plus deductions for any interest we might incur on the loan. But by paying a little cash and getting the contractor to 'lend' us the balance of the money with which to pay for the work, we can repay it after January rents are collected. This also sets the tenant up for a higher rent when we renew the rental agreements at the end or January after all the upgrading has been completed. Another business reason. Valid business expenses incurred to increase profits are the best of all tax strategies.
THE SMALL BUSINESS CORPORATION CAN STILL EARN THE MOST TAX SHELTERED MONEY . . .
We've seen the personal tax rates for this year and next being increased via phase out of deductions and exemptions. Corporate tax rates were unchanged: 15% up to $50,000 AGI, 25% between $50,001 and $75,000 AGI, 34% over $75,000. Personal service corporations (in which the owners of 10% or more of the stock do substantially all of the work in the fields of Accounting, Law, Architecture, Engineering, Actuarial Science, Performing Arts, Medical and Health or Consulting) pay a flat 34%.
Excluding the personal service corporations, regular C corporations can save a middle income family THOUSANDS OF TAX DOLLARS because of special tax rules that apply to them. Unlimited Passive Activity Losses. Deductible Pension Benefits, Medical Reimbursement Plans, Pre-paid Legal Plans, Per Diem, Deductible housing and meal allowances, They can deduct 1/2 of their FICA payments, up to $10,000 deduction for personal property under Section 179 each year. The corporation can pay the owner fair market rents for the use of a vehicle, office space and storage, equipment which it can deduct and which the owner can write off against his own income. But let's talk people.
Suppose you incorporated your business – say rental management, real estate brokerage, buying and selling of mortgages. Everything you spent to keep the business going is deductible against ACTIVE income. Even if you had a regular job which paid you W2 wages, you could still own a corporation which had its own tax identity/bracket. Your spouse works for the corporation and draws a salary with a complete fringe benefit package including a separate pension plan.
Each of your kids also works (within his/her capacity) for the corporation. They might also serve on the Board of Directors for a fee and travel to meetings with all expenses reimbursed. Each employee could be covered by a life insurance policy or disability/health insurance deductible out of corporate profits. You'd effectively be able to transfer income from your tax bracket into the corporate tax bracket where it could be sheltered by business costs and subsequently be taxed at a lower bracket.
Letter Ruling 9134003 allowed a farmer to convert non-deductible personal expenses to deductible, tax free corporate expenses. He formed a corporation and contributed the farm, cars, dwelling, equipment and out buildings to it. Each family member signed an employment contract which required the family to live and to take their meals on the farm which the corporation was obligated to maintain and support. This was for the convenience of their employer, the farm corporation. The key was that they did everything correctly, ran their farm in a businesslike manner, documented everything. You may not have a farm, but the same principals apply.
