LOISELLE, GOODWIN & HINDS
CERTIFIED PUBLIC ACCOUNTANTS

Tax Developments in the Third Quarter of 2000

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 for you while others may not be. Please contact us for more information about any of these developments and any steps you should take to capitalize on favorable developments and to minimize the impact of those that are unfavorable.

Preparing for the upcoming rate cuts for 5-year capital gain. The capital gains tax rules will soon be changing for the better. Right now, long-term gain from the sale of capital assets is taxed no higher than 10% to the extent that it would otherwise be taxed at 15% if it were treated as ordinary income. Such gain generally is taxed no higher than 20% currently to the extent that it would otherwise be taxed at a 28% or higher rate if the profit were treated as ordinary income instead of capital gain. After 2000, gain from the sale of capital assets held more than 5 years that would otherwise be taxed at the 10% rate instead will be taxed at an 8% rate. Additionally, gain that would otherwise be taxed at a 20% rate will be taxed at an 18% rate if (1) the asset sold is held for more than 5 years, and (2) the holding period begins after 2000. Under a deemed sale-and-repurchase election, you can choose to be treated for tax purposes as having sold and repurchased stock on Jan. 2, 2001. You can also choose to treat any other capital asset or property used in a trade or business and held by you on Jan. 1, 2001, as having been sold on that date for its FMV on that date, and repurchased on that date for that FMV. This deemed-sale-and-repurchase election avoids the transaction costs you would otherwise have to pay if you actually sold stock or another eligible asset and then repurchased it in order to eventually qualify for the 18% rate.

The lower rates won’t apply to certain specialized types of gains, such as collectibles gain, which is taxed at a maximum rate of 28%.

Research credit OK’d for development of software suites. A credit is available to corporations that increase spending on research, but claiming this tax break for software development has been all but impossible under the IRS’s approach. In essence, the IRS has maintained (and some courts have agreed) that software development is eligible for the research credit only if a company’s expenses are designed to achieve a discovery in the scientific sense, are technological in nature, and involve a process of experimentation. In okaying the research credit for a company that developed software suites for sale, a court criticized the IRS’s tough tests as being contrary to the credit’s purpose – it was designed to encourage taxpayers to spend money on research to develop new products and thereby stimulate the economy. The court said that the IRS’s tests would adopt an academic research approach and make it virtually impossible for commercial research to qualify for the credit, which was clearly not Congress’s intent. This important decision could result in a liberalization of the research credit rules.

IRS OK’s "reverse swaps." Under liberal IRS rules, it’s possible to restructure a taxable sale of business or investment property as a tax-free exchange if your ultimate goal is to reinvest the sales proceeds in business or investment property of "like kind" to the old property. The deal is done through qualified intermediaries using IRS safe-harbor rules. In the usual exchange (or swap), you give up your old property and then get replacement property in return. Sometimes, however, you may have to receive the replacement property first, before you give up your old property (hence the reverse-swap label). For example, suppose your company wants to sell Building A and reinvest the proceeds in Building B. A reverse swap may become necessary if Building B’s owner must sell it for cash immediately before you can transfer Building A to a qualified intermediary. The IRS’s pre-existing safe-harbor rules for like-kind exchanges didn’t cover reverse swaps, but now the IRS has issued detailed safe-harbor rules for such deals. These rules make it possible to set up reverse swaps as tax-free like-kind exchanges without running the risk of an IRS challenge.

New way to compute net income on recharacterized IRA contributions. If you make a contribution to a traditional IRA, you can change your mind and recharacterize it – that is, treat the contribution as having been made to a Roth IRA. Recharacterization also allows you to turn a Roth IRA contribution into a traditional IRA contribution. To make this strategy work, you must (among other requirements) transfer all of the net income earned by the original IRA contribution to the other type of IRA account when you make the recharacterization. The IRS recently approved a new way to figure the net income that must be transferred. The new method more accurately reflects the actual earnings and losses of the IRA during the time it held the contribution.

Federal per-diem rates revised effective Oct. 1. Instead of reimbursing an employee’s actual lodging, meal and incidental expenses for business travel away from home, an employer may use a per-diem reimbursement. Per-diem reimbursements are payroll-and-income-tax free if made under an "accountable plan" and the per-diem rate doesn’t exceed the federal per-diem rate (the maximum amount that the federal government reimburses its employees) for the locality of travel for that day. These per-diem rates, which vary by travel destination, used to be revised for each calendar year. The IRS has announced that beginning with this year, these rates will be updated effective each Oct. 1, rather than Jan. 1. For the last three months of 2000, the IRS will allow taxpayers to consistently use either the new per-diem rates or those that were in effect for the first nine months of 2000.

Tax-free transit passes may be distributed in advance. Employees may exclude (and employers may fully deduct) transit passes up to $65 a month (for 2000 and 2001). A transit pass is any pass, token, fare card, voucher, or similar item entitling a person to transportation on mass transit facilities, or on qualifying highway commuter vehicles. The IRS now will allow employers to distribute tax-free transit passes in advance for more than one month (e.g., for a calendar quarter). It had previously said that tax-free transit passes had to be provided to employees in a month for that month, or for any previous month in the calendar year.

When brief but recurring workplace assignments are "temporary." Employees can be reimbursed income- and payroll-tax-free for expenses of traveling to a temporary workplace, or for using their own cars to make the trip (if the reimbursement is properly substantiated and made under an accountable plan). Employees who use a company auto to make the trip can count the mileage as a tax-free working condition fringe benefit (as opposed to taxable personal use). Non-reimbursed employees and self-employed taxpayers who use their own vehicles may treat their auto expenses as deductible. In general, a work location is temporary if employment at that location is realistically expected to last (and does in fact last) for one year or less. An employee who normally reports to one regular work location may be required to report to an offsite work location on a recurring, but infrequent or sporadic, basic for a period of more than one year. The IRS says that if an employee is assigned to a work location for more than one year, but is expected to be and actually is present at that location for no more than 35 workdays (partial or complete) during each year, then the location is "temporary."

Business owner’s private jet expenses found to be deductible. A business executive or entrepreneur whose time is extremely valuable may decide to travel via private jet instead of enduring the frustration and delays of commercial travel. A court recently held that an entrepreneur who traveled via private jet could deduct the business-related portion of his out-of-pocket costs (plus depreciation). The expense was reasonable in light of the very high value of the entrepreneur’s time and the hours he saved by using a private jet.

(10/19/00)

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Last modified: February 24, 2001