LOISELLE, GOODWIN & HINDS
CERTIFIED PUBLIC ACCOUNTANTS

Recent Tax Developments

The following is a summary of the most important tax developments that have occurred in the past few months that may affect you, your family, your investments, and your livelihood. Some of these developments may be favorable to you while others may be unfavorable. Please contact us for more information about any of these developments and what steps you should take to take advantage of favorable developments and to minimize the impact of those that are unfavorable.

• Roth Conversions
• Social Security reform
• Leased business autos
• Business meal deductions
• Little-noticed law extends some tax breaks, broadens others
• Safeguarding large charitable contributions of property
• Relief for innocent spouses
• Low interest rates impact many forms of tax planning

Roth reconversions. If you convert a regular IRA to a Roth IRA, you pay tax on the conversion, but if you made the conversion in 1998, you can choose to spread the income from the conversion over four years, thus lessening the tax impact. Those who converted to Roth IRAs before mid-summer of 1998 may have done so when the value of their IRAs was inflated by stock market gains that later evaporated when the markets turned sharply downward. However, their tax liability from the conversion was set by the account value at the time of the conversion -- not at its diminished value after the market correction. To rectify this situation, some undid their Roth IRAs by "recharacterizing" them as regular IRAs and then reconverting the new IRA to a Roth IRA, setting their tax liability based on the then lower account value. Under IRS rules issued in October of 1998, an unlimited number of reconversions were allowed before November 1, 1998. However only one reconversion is allowed between November 1, 1998, and December 31, 1998, and only one additional reconversion is allowed during 1999. These rules are complex. If you plan to move assets between a regular IRA and a Roth IRA, you should get professional advice before doing so.

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Social Security reform. Most knowledgeable individuals believe that Congress will move on Social Security reform during 1999. Although reform proposals haven't taken shape yet, benefits may be reduced for some workers, particularly those who are younger. A can't-lose move for those who can afford to do so is to increase their tax-sheltered retirement nest egg through one or several of the means available to them, be it increased participation in 401(k)-type plans, boosted contributions by self-employeds to their own retirement plans, or maximum contributions to traditional IRAs or Roth IRAs.

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Leased business autos. Final regulations issued in October of 1998, confirm that you can figure your deduction for business use of a leased auto by multiplying the number of business miles you drive during the year by a mileage allowance figure. This figure is 32 1/2¢ for 1998 and the first three months of 1999, but it drops to 31¢ on April 1, 1999. One main attraction of this simplified approach is minimal recordkeeping: all you need do is maintain a written record of the time, place, mileage and purpose of your business-connected trips. By contrast, if you deduct actual business-connected costs for your leased auto, you also must keep records of all your actual expenses (e.g., gas, maintenance and repairs, lease expenses) and allocate expenses between (deductible) business costs and (nondeductible) personal driving costs based on mileage. Before 1998, the simplified deduction method was not available for leased business autos. You should be aware, however, that the mileage allowance method may yield a smaller deduction than you'd get by writing off the business-connected portion of your actual auto costs.

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Business meal deductions. It's perfectly legitimate for you to have occasional business lunches (or dinners) with business associates and deduct half the cost, as long as you actually discuss business at the table, or the meal directly follows or precedes a substantial and bona fide business discussion. What's more, the term "business associates" includes customers, clients, suppliers, employees, agents, partners, and even professional advisers. However, where the meals are shared too frequently, and where the parties in effect share the expenses ("you buy lunch today and I'll treat tomorrow"), the fact that business is discussed at the table won't turn half the cost of the meals into a deduction. Two professionals who shared an office learned this lesson the hard way when a Tax Court ruling in October denied deductions for their frequent lunches. Although they talked business during their meals, their frequency and the fact that the two professionals alternated paying for lunch ruined their deductions.

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Little-noticed law extends some tax breaks, broadens others. The Tax Relief and Trade Extension Act, signed into law in October of 1998 without much fanfare, extended several tax breaks which had already gone off the books, and made several other positive changes. Here's a summary:

• Two tax breaks for business were extended until June 30, 1999 (the tax credit for research, designed to encourage businesses to increase spending on research and experimental activities, and the work opportunity credit, which gives businesses a tax break for hiring workers from certain disadvantaged groups).
• A donor can continue to claim a charitable deduction for the full value of qualified appreciated stock contributed to private foundations. In general, qualified appreciated stock is stock that is capital gain property that is quoted on an established securities market. The term includes mutual fund shares. (The full deduction for these contributions had expired on June 30, 1998, but was retroactively extended and made permanent by the new law.)
• Two highly technical changes increase the tax credits that can be claimed by individuals for tax year 1998. One change applies to "nonrefundable" personal credits (credits that can only be claimed to the extent of tax liability, such as the credit for dependent care, the adoption credit, the child tax credit, and the HOPE Scholarship and Lifetime Learning credits). For 1998 only, persons eligible to claim these nonrefundable credits can use them to offset their regular tax liability in full. Under prior law, in general terms, these credits were allowed only to the extent that an individual's regular income tax liability exceeded his or her tentative minimum tax. Another change applies to those families that have 3 or more qualifying children. Where tax liability is less than the allowable child tax credit, part of the child credit for such a large family may be refundable. For 1998 only, the "refundable" child credit available for these large families is not reduced by an individual's alternative minimum tax liability (i.e., the amount by which the tentative minimum tax exceeds regular tax liability).
• Self-employed persons can deduct a percentage of their health insurance costs if they aren't eligible to participate in a subsidized health plan maintained by their employers or their spouses' employers. The percentage was 45% for 1998, but thanks to the new law, will be increased to 60% for 1999, 2000, and 2001; to 70% for 2002; and to 100% for 2003 and later. The percentage would have increased under prior law, too, but at a slower rate.

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Safeguarding large charitable contributions of property. Persons intending to make large charitable donations of property should consult with knowledgeable tax advisers beforehand to ensure that anticipated tax benefits will in fact materialize. Expert advice is necessary because of the special tax rules that apply to these donations. For example, special appraisal requirements must be met where the claimed value of a charitable contribution of property exceeds $5,000 ($10,000 for nonpublicly traded securities). A couple found this out the hard way when they claimed a $121,000 deduction for nonpublicly traded stock they contributed to a charity. Under IRS's regulations, they should have, but failed to, have the stock appraised and attach a summary of the appraisal to their returns for the contribution years. In December of 1998, the Fourth Circuit Court of Appeals held that because they didn't get the necessary appraisal, their charitable deduction was limited to their basis (their cost for tax purposes) in the stock, a mere $6,500. The couple was stuck with this unfortunate result even though they properly valued their donations of stock, based on average prices at which stock of the same issuer traded hands in bona-fide, arm's length transactions.

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Relief for innocent spouses. As a general rule, the signers of a joint tax return for a year are jointly liable for paying taxes for that year along with any interest or penalties that may be due. Innocent spouses (e.g., those who didn't know about their spouses' underreporting of income) were entitled to limited relief from joint liability under prior law, but have been granted the following additional relief by Congress:

1. The circumstances under which innocent spouse relief (which applies to all joint filers) is available has been expanded.
2. Joint filers who are divorced, widowed, legally separated, or have not lived together for the past 12 months can make an election to allocate a deficiency. In broad terms, these taxpayers can elect to limit their liability for any tax deficiency to the portion of the deficiency that is attributable to items that are allocable to them. Items generally are allocated between spouses as they would have been allocated had they filed separately.
3. A taxpayer may be entitled to equitable relief -- this applies to all joint filers and to married couples filing separate returns in community property states. This relief may be available where it would be inequitable to hold an individual responsible for unpaid taxes or deficiencies from a joint return.

Innocent spouse relief and the election to allocate a deficiency apply only to items incorrectly reported on the return. If a spouse does not qualify for innocent spouse relief or the election to allocate a deficiency, then equitable relief (item 3, above) may be available.

These rules apply to tax liabilities arising after July 22, 1998, and tax liabilities arising on or before July 22, 1998, that were unpaid as of that date. In December of 1998, the IRS issued detailed, complex regulations explaining each of these forms of relief. The exact application of these rules depends on a person's particular circumstances.

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Low interest rates impact many forms of tax planning. Today's low interest rates represent good news for prospective homebuyers and existing homeowners who may benefit by refinancing their mortgages. Lower interest rates also can have a significant impact on the income, estate, and gift tax value of many types of transfers. In some cases, the drop in rates produces more favorable results. In other cases, however, the lower rates result in higher tax costs.

• The private annuity is one planning technique that works better with lower interest rates. In the typical private annuity transaction, a parent transfers property to his child in return for that child's unsecured promise to pay the parent a fixed, periodic income for life. If the fair market value of the property transferred equals the present value of the annuity under IRS valuation tables, there is no gift tax due. A decrease in the interest rate lowers the annual payment amount that the younger family member has to make to the older family member to prevent a gift from arising on the transfer.
• The charitable remainder annuity trust is one planning technique that doesn't work as well with lower interest rates. With a charitable remainder annuity trust, the donor retains an annuity interest for himself or someone else, such as a family member, and names a charity to receive the remainder at the end of the annuity term. The donor gets a current income tax deduction for the present value of the charity's remainder interest. A lower interest rate produces smaller income, gift, and estate tax charitable deductions and increases the value of the gift of the annuity interest where the annuity is not retained by the donor but is given to someone else.

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(12/31/98)

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Last modified: July 09, 1999