Q:

Kerry;

Wow, we never realized my daughter would inherit the cost basis of my dad on the stock. Since it started out at $200 and is now around $10,000 that makes a difference. Since we keep her income below the amount that she needs to file a return (I believe it  is $4,800?) would we have to file a return if she cashes in only amounts that keep her under that $4,800?  If we cashed out part now and then  part in January 2006 would that work?  She has currently earned $1,800 from working for our company and was going to have a job this summer. Perhaps her tax basis will be low enough that the amount she would be taxed would be minimal anyway.

We always enjoy reading your newsletter each morning and saw our question in there. Reading other peoples questions and your answers is always a great education tool for us.

Thank-you;

A:

That is the big difference between receiving appreciated assets via gift versus via inheritance.  With an inheritance, the heir’s cost basis is stepped up to the asset’s fair market value as of the date of death.  This effectively wipes out the decedent’s capital gain; although it could result in estate tax if there is a large enough taxable estate.

The standard deduction for 2005 is an even $5,000, so if she has less total gross income than that for this year, she won’t be required to file a 1040.  Filing a tax return is a bit of a hassle and expense; but it still may make sense if she needs to sell off more than $3,200 worth of the stock.  Odds are that her effective tax rate will be much lower than it is for your parents, such as 5% instead of the 15% they would probably owe for Federal income tax.

As you should have noticed in many of my other postings, I have always believed it to be a big mistake to hold onto stocks just based on the tax effects.  Hold or sell decisions should be purely based on whether that stock is a good investment.  If is looks like it has peaked and is about to dive, it would be nuts to hold onto it just to avoid going over the $5,000 income threshold.  The 5% taxes saved will be small compared to the actual dollar loss in the stocks.

As you noticed, I do use these emails as an educational tool for my readers.  One point that may not apply in your daughter’s case, but I have seen in others.  The $5,000 income level for a tax return filing requirement is based on the gross income, not the net profit.  This is a big mistake I have seen many people make.  They may sell stock for $50,000 that has a cost basis of $49,000, or more often, more than the $50,000.  Assuming that the tiny net gain or net loss isn’t enough to warrant filing a 1040, they don’t. 

What eventually happens is that IRS receives the 1099-B from the stockbroker showing $50,000 of stock sales.  When they don’t see a tax return reporting this, IRS computers spit out a letter claiming that there was unreported income, along with a bill for taxes, interest and penalties on $50,000 of ordinary income.  Unless a taxpayer tells them otherwise by filing a tax return with Schedule D, IRS literally assumes that the stock had a zero cost basis and that it was owned for less than 12 months, subjecting it to ordinary tax rates rather than the lower long term capital gain rates. As I constantly emphasize, filing tax returns, even when there may be no tax effect, is a self defense measure that can head off problems such as this.

I hope this helps your family work out the best game plan.  Let me know if you have any other questions.

Kerry

 

The Vulture Tax – Stephen Moore has another very appropriate name for the communistic estate tax.  If our rulers in DC can’t kill it now, with full GOP control, it may never go away.  The chances of ending this evil confiscation will drop to zero after 2008, when the Clintons are coronated for their third term in the White House.  Those two are the most avid supporters of Karl Marx’s principles as any president in our history.

Q:

Subject: Incorporation

 

Our PTA is being asked by the local BSA to charter them.  We are trying to get all information possible and someone suggested incorporation.

Our main concern is “willful acts”  and the liability taken on by the officers.  Would incorporation be possible?  How hard is it?  How would this protect us?

Who would this protect?  Would a local PTA be able to incorporate?

I hope you can help!
Thank you for your time!

A:

It sounds as if you need to be more concerned with the legal liability issues than any tax issues.  Thus, this is out of my area of expertise.

While Nolo Press has some excellent resources for working with nonprofit organizations, it would a prudent move to consult with an attorney who is familiar with the liability rules for nonprofits in your state.  They do vary in different jurisdictions.

Good luck.

Kerry Kerstetter

 

Q:

Subject: Choosing A Fiscal Year

 

Hi,

 

I read your article on choosing a fiscal year, and, as a recently new (solo) owner of a Corporation (in the state of Delaware), I just was wondering what’s the best month to choose as the start of a fiscal year?

 

I literally just incorporated a week ago (May 12th, 2005).

 

Thanks for any helpful info,

A:

I just added some more info to my page on choosing a tax year that discusses the ideal month to use. 

If you do use the June 30 date, this will mean that your first tax return will be a very short year, from May 12, 2005 through June 30, 2005.  If that concerns you, you may want to opt for the next best choice, March 31.

Good luck.

Kerry Kerstetter

 

Q:

Subject: Question on College Gifts

 

Kerry;

 

Our daughter is graduating from high school this June. Her grandparents want to gift her stock and cash to help pay for college. I am not sure of the amounts but was wondering if I need to consider tax ramifications. Is there a certain amount we  should try to stay with in each year?

 

Thank-you;

 A:

The issue of gifting has several facets to it, many of which your parents should discuss with their personal tax advisor.  The following should help them in their game plan.

First, from the perspective of you and your daughter, the receipt of gifts is one of the few things that is entirely exempt from income tax.  There is a potential gift tax that would be levied on the givers, which I will discuss below.

Next is the issue of cost basis of the gifts for your daughter.  With cash gifts, the issue of basis is moot.  It is just what is received.  However, for non-monetary assets, such as stocks, it gets trickier.  For gift tax purposes, their fair market values at the time of the gift are used.  For publicly traded stocks, that is just the current market price. 

For the cost basis to the recipient, she must use the lower of the giver’s cost basis or its fair market value.  This is normally a serious issue with highly appreciated assets because it means that the givers (aka donors) are also transferring the potential capital gains tax obligations to the recipient. As an example, suppose your parents paid  $10 per share for a stock that is now worth $100 per share.  For gift tax reporting, the $100 per share value is used.  However, for your daughter, her cost basis in the stock remains at just $10 per share.  This won’t trigger any taxes until she sells the stock, at which time her gain will be the excess over $10.  So, if she were to sell the stock shortly after receiving it, she would have a long term capital gain of $90 per share to report on her income tax return.  Her holding period does include that of the previous owner.  This isn’t necessarily a bad thing overall and is often done intentionally if the recipients are in a lower tax bracket than the givers were or have other capital losses that can offset the gains.

If the asset has gone down in value from the giver’s cost basis, a gift is generally not a smart move, tax-wise.  Suppose the numbers in the above example were reversed.  Your parents paid $100 per share for stock that is now only worth $10 per share.  While the gift tax would be based on the $10 per share value, so would the cost basis for your daughter.  This effectively eliminates the opportunity for anyone to deduct the $90 per share capital loss.  In cases like this, it would be better for your parents to sell the stock and claim the $90 per share capital loss on their tax return and just give the cash to your daughter.

Now from the perspective of your parents, the givers, and their gift tax requirements.

There is an annual tax free allowance that many people use in order to time their gifting and avoid the need to file any gift tax returns.  It is currently at $11,000 per donor per donee per year.  That means your mother could give your daughter $11,000 and your father could also give her $11,000, for a combined total of $22,000.  As I mentioned above, the values are the fair market values of the assets.

If they give more than the annual tax free allowance, they will have to file a gift tax return (Form 709) to report the gifts to IRS.  Because these would be gifts from grandparents to a grandchild, they would be possibly subject to the 47% Generation Skipping Transfer (GST) Tax, rather than the normal Gift Tax.  They have the option of either paying the tax or using part of their lifetime exclusion, which is now $1.5 million per person.  That’s $3 million combined for your mother and father.  On their 709s over the years, they are required to keep a running tally of how much of that lifetime exclusion they have used.  This actually carries over to their estate tax returns (Form 706) to see how much of their lifetime exclusion is still available to be used against that tax.

Now for a little fact that might help you all to decide how to structure things.  The above discussion dealt with transfers from your parents to your daughter.  There are a few types of transfers that are not required to be even counted when considering gift or GST taxes.  Those are direct payments for medical costs and for tuition.  So, if your parents were to pay your daughter’s tuition directly to the college, no reporting to IRS is needed.  If, however, they give money directly to your daughter and she uses it to pay for her tuition and other school costs, there could be gift tax reporting requirements if the total paid during a calendar year exceeds the $11,000 per donor/giver threshold. 

What would probably work out best is for your parents to pay the college directly for the tuition and then gift your daughter other money to cover her books, supplies and dormitory fees, which are not covered by the special exemption.  Of course, they should work out their strategy with their own tax advisor.

This is probably a longer and possibly more confusing answer than you expected.  However, who can make the claim that tax matters are simple in this country? Let me know if you need to discuss any of these points in more detail.

Kerry

 

Q:

I am a CPA using QuickBooks.  I am looking for a way to have better looking financial statements than I can get in QuickBooks.  Do you have a recommendation for a product?

Thanks.

A:

I’m sorry but I don’t have any add-on products to recommend.

If you are using a version of QuickBooks from before 2005, you may want to check out the latest one.  They have incorporated the financial statement designer program into it rather than have it as a separate stand-alone program.  With it, as well as the ability to export reports to Excel, I have yet to be unable to produce the kinds of reports I need.

Good luck.

Kerry Kerstetter

Follow-Up:

Kerry,

Thanks for your response.  I am trying to do the links with Excel.  It is working ok but if new accounts are added it will have to be worked on.  The reports do look nice.

Thanks.

 

Q:

Kerry,

Someone recently told us that if you have a “historic building” or a building built before (I can’t remember what) date, then there were some tax credits available.  I don’t know where to get the info on this subject, but the building you’ll see on our balance sheet … was built in like 1912.  It’s vacant right now as it needs repairs, but I just wanted you to know so when you get to our 2004 return, we might get some extra deductions.

A:

The tax credit you are referring to is the historic rehab credit, which I think I covered in the seminars I was presenting with Wayne Camp.  It’s been around since the Tax Reform Act of 1986.

To summarize, an investment tax credit of 20% is allowed against the  rehab costs on business use buildings that are listed in the Federal National Register.

The credit is 10% of the rehab costs for buildings that were originally placed into service prior to 1936, which was intended to include any over 50 years old when the law was passed.

There are some restrictions on what percentage of the interior and exterior walls have to be retained in order to prevent people from completely tearing buildings down and erecting new ones.

The credit is non-refundable, which means it can only be used to offset Federal income tax, and not SE tax.  The unused portion can be carried forward.  I have one client … who rehabbed a certified historic building … about ten years ago, and we are still carrying forward about $10,000 for the credit.

I will make sure to enter the rehab costs accordingly for your 1912 building.  The purchase of the building itself doesn’t qualify for the credit.  Just the rehab costs do.

Kerry