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There are several new procedures that the State of Illinois is implementing in order to increase compliance with existing laws and thereby, increase revenues. Illinois and most other states are increasingly using computer programs to match information in order to identify underreported or unreported income and sales transactions.

Illinois has started a new discovery project. The program records taxpayers who have been filing Illinois tax returns as residents and then change to non-residents. Illinois then monitors the taxpayer for a spike in AGI. If there is a spike in AGI after the residency change, Illinois will investigate. This procedure has been put in place in order to identify a taxpayer who changes his or her residence to a lower taxed state prior to selling an asset at a large gain or receiving a large amount of income.

Illinois is cross checking whatever documents they have available to further taxpayer filing compliance. For instance, when a business applies for a lottery license, Illinois will check for compliance with the sales tax filings. This is also the method that was used very successfully in forcing gas stations into compliance.

Illinois has also been very successful in getting information from the customs department for use tax notifications. A program in which custom declaration forms are used to verify whether use tax has been paid on items that a taxpayer has  brought into Illinois is in place in order to collect use tax from those Illinois residents.

States are also sharing  more  information with each other. A taxpayer bought a boat in Florida and told Florida that the boat was going to Illinois so no use tax was due to Florida. Florida notified Illinois who in turn notified the taxpayer and had the taxpayer remit the Illinois use tax.

Computer matching programs are being used more and more successfully at various levels of government in order to ensure compliance with tax laws. If a computer matching program identifies a potential discrepancy, it will generate a notice to the taxpayer. If you receive a notice of this kind, please do not ignore it. Ignoring it will not make it disappear but will only raise the issue to a higher level. Contact us for assistance and we will be glad to help you address the issue.

Ho began his fine wine career in 1977 at the American Restaurant, the finest gourmet establishment in Kansas City, Missouri. Within a year he had been appointed the sommelier, and in 1978 assisted in earning the restaurant a prestigious Mobil 5-Star rating. At that time, he discovered that wine collection and appreciation was a little-practiced hobby here—perhaps only one in every 200 people was a consumer of fine wine (bottles priced at $10 or higher). Over the past few decades, however, Ho has watched as the culture has changed, and more and more Americans began to develop their inner oenophiles. Today, it is estimated that wine is enjoyed by a third of the population. With the demand increasing for quality wine, and standard liquor stores unable to meet these customers’ needs, Ho established the Knightsbridge Wine Shoppe in Northbrook in 1986, and over the next twenty years built it into a successful and respected fine wine outlet. In 1999, Chicago Magazine named Knightsbridge the Best Wine Shop, and in 2000 Ho himself was honored as “The Windy City’s Wizard of Wine” by Market Watch Magazine.

In 2006, Ho noted that the wine culture was continuing to evolve, and that there was an increasing desire for more upscale wine. While many still appreciated the average $15 wines, more discerning customers were looking to purchase bottles that merited a higher price tag. With that in mind—and with the knowledge he had accrued and refined from running Knightsbridge—Ho established Pantheon, which stocks wines that average around $200 per bottle. Pantheon also caters to its clients by offering cellar design services for those who want to build their own wine storage at home. “It started as a favor to a client,” Ho explains. “And then it became a business. I got ideas from chateaus and castles I had seen…[Pantheon] is able to provide a new genre of sophisticated wine cellar design.”

Ho notes that with the growth of the wine industry in America, the bureaucracy and cost of starting and maintaining a wine-based business has become substantially more complicated. Whereas Ho was able to start his first wine shop with approximately $2500 to cover all licenses and insurance, today the renewals alone can cost four times as much, and require many more forms and accounting reports. To help him manage the paperwork, Ho employs the services of KRD CPAs. Jon Segal, a partner at KRD, has worked with Ho for over 23 years, and when Segal returned to KRD in 2001 Ho was happy to follow him there. KRD helps Pantheon file their tax reports, assess their insurance and risk factors, and answer questions from outside inspectors or auditors.

Ho’s plans for the future of Pantheon are towards focused, healthy growth. He believes in building his business synergistically, avoiding avenues that do not fit his company’s philosophy of providing top expertise and top customer service. You may visit their website at: http://www.pantheonws.com/

“Clients appreciate what we bring to their table…literally.” Ho quips. KRD looks forward to helping Pantheon achieve its goals.

First, remember that effective tax planning requires considering both this year and next year—at least. Without a multiyear outlook, you can’t be sure maneuvers intended to save taxes on your 2011 return won’t backfire and cost additional money in the future. For example, postponing a stock sale gain until next year would reduce your 2011 adjusted gross income, but increase the 2012 figure. Higher income next year could make you ineligible for the child tax credit, reduce or eliminate the credits or deduction for college expenses, limit deductible losses from your rental real estate investments, and so on.

Second, be on the alert for the Alternative Minimum Tax (AMT) this year. It’s an add-on tax over and above your regular income tax. Although you may have never owed AMT in the past, your odds of being hit are higher now because the tax brackets, standard deduction, and personal exemption allowances used in calculating your regular tax liability are all indexed annually for inflation. Most AMT parameters are not. The odds of owing the tax go up every year due to this factor alone. The risk goes up another notch or two if you deduct a significant amount of state and local taxes or miscellaneous itemized deductions (like unreimbursed employee business expenses) or claim multiple dependents. These deductions are not allowed against the AMT. Finally, if you exercised incentive stock options or recognized a large capital gain this year, consider yourself a likely AMT victim.

Here are a few tax-saving ideas to get you started. As always, you can call on us to help you sort through the options and implement strategies that make sense for you.

• Bigger Section 179 Deduction. Your business may be able to take advantage of the temporarily increased Section 179 deduction. Under the Section 179 deduction privilege, an eligible business can often claim first-year depreciation write-offs for the entire cost of new and used equipment and software additions. (However, limits apply to the amount that can be deducted for most vehicles.) For tax years beginning in 2011, the maximum Section 179 deduction is $500,000. For tax years beginning in 2012, however, the maximum deduction is scheduled to drop back to $125,000.
• Section 179 Deduction for Real Estate. Real property costs are generally ineligible for the Section 179 deduction privilege. However, an exception applies to tax years beginning in 2011. Under the exception, your business can immediately deduct up to $250,000 of qualified costs for restaurant buildings and improvements to interiors of retail and leased nonresidential buildings. The $250,000 Section 179 allowance for these real estate expenditures is part of the overall $500,000 allowance. This temporary real estate break will not be available for tax years beginning after 2011 unless Congress extends it.

Note: Watch out if your business is already expected to have a tax loss for the year (or be close) before considering any Section 179 deduction, as you cannot claim a Section 179 write-off that would create or increase an overall business tax loss. Please contact us if you think this might be an issue for your operation.

• 100% First-year Bonus Depreciation. Above and beyond the bumped-up Section 179 deduction, your business can also claim first-year bonus depreciation equal to 100% of the cost of most new (not used) equipment and software placed in service by December 31 of this year. For a new passenger auto or light truck that’s used for business and is subject to the luxury auto depreciation limitations, the 100% bonus depreciation break increases the maximum first-year depreciation deduction by $8,000 for vehicles placed in service this year. The 100% bonus depreciation break will expire at year-end unless Congress extends it.

Note: 100% bonus depreciation deductions can create or increase a Net Operating Loss (NOL) for your business’s 2011 tax year. You can then carry back a 2011 NOL to 2009 and 2010 and collect a refund of taxes paid in those years. Please contact us for details on the interaction between asset additions and NOLs.

Claim the Health Insurance Tax Credit for Small Employers. Qualifying small employers can claim a tax credit that can potentially cover up to 35% of the cost of providing health insurance coverage to employees. A qualifying small employer is one that: (1) has no more than 25 Full-time Equivalent (FTE) workers, (2) pays an average FTE wage of less than $50,000 and (3) has a qualifying healthcare arrangement in place. The allowable credit is quickly reduced under a complicated phase-out rule when the employer has more than 10 FTE employees or an average FTE wage in excess of $25,000. Please contact us if you have questions about this break.

Evaluate Inventory for Damaged or Obsolete Items. Inventory is normally valued for tax purposes at cost or the lower of cost or market value. Regardless of which of these methods is used, the end-of-the-year inventory should be reviewed to detect obsolete or damaged items. The carrying cost of any such items may be written down to their probable selling price (net of selling expenses). [This rule does not apply to businesses that use the Last-in, First out (LIFO) method because LIFO does not distinguish between goods that have been written down and those that have not].

To claim a deduction for a write-down of obsolete inventory, you are not required to scrap the item. However, in a period ending not later than 30 days after the inventory date, the item must be actually offered for sale at the price to which the inventory is reduced.

Employ Your Child. If you are self-employed, don’t miss one last opportunity to employ your child before the end of the year. Doing so has tax benefits in that it shifts income (which is not subject to the Kiddie tax) from you to your child, who normally is in a lower tax bracket or may avoid tax entirely due to the standard deduction. There can also be payroll tax savings since wages paid by sole proprietors to their children age 17 and younger are exempt from both social security and unemployment taxes. Employing your children has the added benefit of providing them with earned income, which enables them to contribute to an IRA. Children with IRAs, particularly Roth IRAs, have a great start on retirement savings since the compounded growth of the funds can be significant.

Remember a couple of things when employing your child. First, the wages paid must be reasonable given the child’s age and work skills. Second, if the child is in college or entering soon, having too much earned income can have a detrimental impact on the student’s need-based financial aid eligibility.

Make Charitable Gifts of Appreciated Stock. If you have appreciated stock that you’ve held more than a year and you plan to make significant charitable contributions before year-end, keep your cash and donate the stock (or mutual fund shares) instead. You’ll avoid paying tax on the appreciation, but will still be able to deduct the donated property’s full value. If you want to maintain a position in the donated securities, you can immediately buy back a like number of shares. (This idea works especially well with no load mutual funds because there are no transaction fees involved.)

However, if the stock is now worth less than when you acquired it, sell the stock, take the loss, and then give the cash to charity. If you give the stock to charity, your charitable deduction will equal the stock’s current depressed value and no capital loss will be available. Also, if you sell the stock at a loss, you can’t immediately buy it back as this will trigger the wash sale rules. This means your loss won’t be deductible, but will instead be added to the basis in the new shares.

Maximize the Benefit of the Standard Deduction. For 2011, the standard deduction is $11,600 for married taxpayers filing joint returns. For single taxpayers, the amount is $5,800. Currently, it looks like these amounts will be about the same for 2012. If your total itemized deductions are normally close to these amounts, you may be able to leverage the benefit of your deductions by combining deductions in every other year. This allows you to time your itemized deductions so that they are high in one year and low in the next. You claim actual expenses in the year they are combined and take the standard deduction in the intervening years.

For instance, you might consider moving charitable donations you normally would make in early 2012 to the end of 2011. If you’re temporarily short on cash, charge the contribution to a credit card—it is deductible in the year charged, not when payment is made on the card. You can also accelerate payments of your real estate taxes or state income taxes otherwise due in early 2012. But, watch out for the AMT, as these taxes are not deductible for AMT purposes.

Combine Deductions Subject to an Adjusted Gross Income Limit. Miscellaneous itemized deductions (such as unreimbursed employee business expenses) are deductible to the extent they exceed 2% of your adjusted gross income (AGI). (Your AGI is the number at the bottom of the first page of your return.) Medical expenses are deductible only to the extent they exceed 7.5% of AGI. To lessen the affect of these AGI limitations, try to combine your miscellaneous and medical expense deductions into every other year.

Between now and year-end, you can sell enough losers to offset any capital gains recognized earlier this year. Plus, you can sell enough to generate another $3,000 in losses ($1,500 for married filing separate status), which then can be deducted against your income from all other sources. Since selling the losers reduces your income, the odds are increased that you’ll qualify for various other tax breaks.

If your year-to-date sales have resulted in an overall loss in excess of $3,000, you can sell enough winners between now and year-end to get back to the “negative $3,000” level. Cashing in gains to that extent won’t add a cent to your federal tax bill, whether or not the assets have been held over 12 months. On the other hand, if your year-to-date sales are currently standing at zero or a net gain and you want to unload some winners, but no more losers, before year-end, try to sell only those you’ve owned over 12 months. The resulting gains will be taxed at no more than 15%.

When selling stock or mutual fund shares, the general rule is that the shares you acquired first are the ones you sell first. However, if you choose, you can specifically identify the shares you’re selling when you sell less than your entire holding of a stock or mutual fund. By notifying your broker of the shares you want sold at the time of the sale, your gain or loss from the sale is based on the identified shares. This sales strategy gives you better control over the amount of your gain or loss and whether it’s long-term or short-term.

Secure a Deduction for Nearly Worthless Securities. If the dismal economy has left you with securities that are all but worthless with little hope of recovery, you might consider selling them before the end of the year so you can capitalize on the loss this year. You can deduct a loss on worthless securities only if you can prove the investment is completely worthless. Thus, a deduction is not available, as long as you own the security and it has any value at all. Total worthlessness can be very difficult to establish with any certainty. To avoid the issue, it may be easier just to sell the security if it has any marketable value. As long as the sale is not to a family member, this allows you to claim a loss for the difference between your tax basis and the proceeds (subject to the normal rules for capital losses and the wash sale rules restricting the recognition of loss if the security is repurchased within 30 days before or after the sale).

Employer Stock Options. If you own appreciated stock acquired by exercising Incentive Stock Options (ISOs) and are now considering selling as part of your overall year-end strategy, remember what it takes to qualify for the 15% rate. First, the shares must be held over two years from the option grant date (the date you received the ISO). Second, the shares must be held over 12 months after the exercise date (the date you acquired the stock by exercising your ISO). Selling sooner means all or part of your gain may be taxed at your higher ordinary tax rate.

What if you own nonqualified options? It may pay to exercise now, if there’s just a modest spread between market value, your exercise price, and you expect the stock to appreciate. You will owe tax at your ordinary rate on the spread, but any future appreciation will qualify for the 15% rate if you’ve held the shares over 12 months by the time you sell.

If you already own shares from exercising nonqualified options, remember your post-exercise gains will qualify for the 15% rate as long as more than 12 months have passed since you acquired the stock. A shorter holding period means your gain will be taxed at your higher ordinary rate, unless you have offsetting capital losses from other transactions this year.

Be careful—to qualify for this special tax break, the funds must be transferred directly from your IRA to the charity. Also, this favorable provision will expire at the end of this year unless Congress extends it. So, this could be your last chance.

Take Your Required Retirement Distributions. The tax laws generally require individuals with retirement accounts to take withdrawals based on the size of their account and their age every year after they reach age 70¹/₂. Failure to take a required withdrawal can result in a penalty of 50% of the amount not withdrawn. There’s good news for 2011 though—QCDs discussed above count as payouts for purposes of the required distribution rules. This means, you can donate all or part of your 2011 required distribution amount (up to the $100,000 limit on QCDs) and convert taxable required distributions into tax-free QCDs.

Also, if you turned age 70¹/₂ in 2011, you can delay your 2011 required distribution to 2012 if you choose. But, waiting until 2012 will result in two distributions—the amount required for 2011 plus the amount required for 2012. While deferring income is normally a sound tax strategy, here it results in combining income into 2012. Thus, think twice before delaying your 2011 distribution to 2012—combining income into 2012 might throw you into a higher tax bracket or have a detrimental impact on your other tax deductions in 2012.

Take Advantage of Flexible Spending Accounts (FSAs). If your company has a healthcare and/or dependent care FSA, before year-end you must specify how much of your 2012 salary to convert into tax-free contributions to the plan. You can then take tax-free withdrawals next year to reimburse yourself for out-of-pocket medical and dental expenses and qualifying dependent care costs. Watch out, though, FSAs are “use-it-or-lose-it” accounts—you don’t want to set aside more than what you’ll likely have in qualifying expenses for the year.

Married couples who both have access to FSAs will also need to decide whose FSA to use. If one spouse’s salary is likely to be higher than what’s known as the FICA wage limit (which is $106,800 for this year and will likely be somewhat higher next year) and the other spouse’s will be less, the one with the smaller salary should fund as much of the couple’s FSA needs as possible. The reason is the 6.2% social security tax levy for 2012 is set to stop at the FICA wage limit (and doesn’t apply at all to money put into an FSA). Thus, for example, if one spouse earns $115,000 and the other $40,000 and they want to collectively set aside $5,000 in their FSAs, they can save $310 (6.2% of $5,000) by having the full amount taken from the lower-paid spouse’s salary versus having 100% taken from the other one’s wages. Of course, either way, the couple will also save approximately $1,400 in income and Medicare taxes because of the FSAs.

If you currently have a healthcare FSA, make sure you drain it by incurring eligible expenses before the deadline for this year. Otherwise, you’ll lose the remaining balance. It’s not that hard to drum some things up: new glasses or contacts, dental work you’ve been putting off, or prescriptions that can be filled early. Although, over-the-counter drugs (e.g., aspirin and antacids) no longer qualify for reimbursement by healthcare FSAs, bandages and medical equipment (e.g., thermometers and blood pressure monitoring devices) do qualify.

Adjust Your Federal Income Tax Withholding. If it looks like you are going to owe income taxes for 2011, consider bumping up the Federal income taxes withheld from your paychecks now through the end of the year. When you file your return, you will still have to pay any taxes due less the amount paid in. However, as long as your total tax payments (estimated payments plus withholdings) equal at least 90% of your 2011 liability or, if smaller, 100% of your 2010 liability (110% if your 2010 adjusted gross income exceeded $150,000; $75,000 for married individuals who filed separate returns), penalties will be minimized, if not eliminated.

You should review your estate planning documents to ensure that any formulas contained in your documents, which may transfer certain amounts to certain individuals or trusts based on the estate tax exemption or GST exemption still make sense for you given the recent increase in those exemptions. Those clients who live in a state with an independent state death tax should also review formula allocations in their estate planning documents that take into account state death taxes to assess the effect of the federal estate tax exemption, which is now significantly greater than most state death tax exemptions.

An estate planning opportunity would be to take advantage of historically low interest rates by entering into intra-family loans or establishing Grantor Retained Annuity Trusts (GRATs), which are irrevocable trusts designed to transfer the appreciation in an asset to beneficiaries at a nominal gift cost. For recently created GRATs, the Code Section 7520 rate has been at an all-time low. There is proposed legislation in Congress to restrict the ability to use certain short term GRATs in the future which is why it is important to take advantage of these opportunities now.

Planning to rent out your vacation getaway? When it comes to taking advantage of the tax benefits, timing is an important factor. Here are two points to remember.

The fourteen-day-or-ten-percent test. The IRS applies this test to determine if you use your vacation home as a personal residence. If you stay in the home more than 14 days or 10% of the total days it’s rented in a calendar year (whichever is greater), the general rule is you’re using it as your home.

Why does it matter? Because treating a vacation home as your personal residence affects your rental deductions. You’d include all the rent you receive as income on your tax return. But related expenses are generally limited to the amount of that income, meaning you can’t offset other income with a loss. Note that time spent in your vacation home by family members and certain others can count as personal use.

The less-than-fifteen exception. Rent out your vacation home for less than 15 days during the taxable year, and the income is yours, tax-free. You don’t even have to report it on your return. Just be aware that any expenses related to the rental are nondeductible. If you itemize, you can still deduct qualified mortgage interest and real estate taxes on your vacation home.

Other tax rules, such as passive activity and capital gains reporting, can also impact the decision to rent out your vacation home. Give us a call before you put up that “For Rent” sign. We’ll be happy to review your options under the tax rules.

More Tax Ideas: Summer Trip, Boat, RV, Summer Camp, Hiring Your Child

• If you have summer travel plans and the primary purpose of your trip is business, you can deduct all the travel costs to and from your business destination and all other business-related costs even if you add on a few extra days for pleasure. You can’t deduct costs related to the pleasure portion. Including a spouse or friend on your trip is permissible, but you can’t deduct the additional costs for that person.

• If you itemize your deductions, you can deduct the mortgage interest and property taxes paid for your vacation home. A boat or RV can qualify as a vacation home if it has sleeping quarters, cooking facilities, and a bathroom. If a retreat also serves as rental property, you can control your tax deductions by changing the number of days you use it for vacation.

• If you and your spouse work, the cost of sending your children to a summer day camp may qualify for the child care credit.

• If you own a business, consider hiring your child for the summer. Your child can earn up to $5,800 tax-free this year, and your business is entitled to a deduction for the wages paid. You must pay your child a reasonable wage for the work performed. If your business isn’t incorporated, a child under 18 is not subject to FICA taxes.

IRS Issues Warning: Electronic Federal Tax Payments (EFTPS) Email Scam

The IRS issued a warning June 29 about a fraudulent scheme targeting Electronic Federal Tax Payment System (EFTPS) users. The scheme uses an email claiming that the user’s tax payment was rejected and directs the user to a website for additional information. The website contains malware that will attempt to infect the user’s computer. Taxpayers who responded to this scam and believe they may have become the victim of identity theft, should take steps set forth by the IRS.

The IRS has provided information for taxpayers should they receive a suspicious IRS-related communication; how to identify phishing email scams claiming to be from the IRS and bogus IRS websites; and what taxpayers should do if they receive a suspicious email that does not claim to be from the IRS.

The IRS does not initiate taxpayer communications through email.

If you receive a message claiming to be from the IRS or EFTPS, do not reply to the sender, access links on the site or submit any information to them. Report phishing email scams and bogus IRS websites, by forwarding the email or URL information to the IRS at phishing@irs.gov.

Here’s an example of one variation of the current scam received by one of our clients. We removed the dangerous link from the blue highlighted exe file. It looks real but it’s entirely a fake!

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Several clients of ours have received the same and similar scam email messages.  If you have questions or need additional information, please contact me or your KRD representative.

Judy Kearney, CPA, MST
(847) 240-1040 ext.129
jkearney@krdcpas.com

June 23, 2011
WASHINGTON — The Internal Revenue Service today announced an increase in the optional standard mileage rates for the final six months of 2011. Taxpayers may use the optional standard rates to calculate the deductible costs of operating an automobile for business and other purposes.

The rate will increase to 55.5 cents a mile for all business miles driven from July 1, 2011, through Dec. 31, 2011. This is an increase of 4.5 cents from the 51 cent rate in effect for the first six months of 2011, as set forth in Revenue Procedure 2010-51.

In recognition of recent gasoline price increases, the IRS made this special adjustment for the final months of 2011. The IRS normally updates the mileage rates once a year in the fall for the next calendar year.

“This year’s increased gas prices are having a major impact on individual Americans. The IRS is adjusting the standard mileage rates to better reflect the recent increase in gas prices,” said IRS Commissioner Doug Shulman. “We are taking this step so the reimbursement rate will be fair to taxpayers.”

While gasoline is a significant factor in the mileage figure, other items enter into the calculation of mileage rates, such as depreciation and insurance and other fixed and variable costs.

The optional business standard mileage rate is used to compute the deductible costs of operating an automobile for business use in lieu of tracking actual costs. This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.

The new six-month rate for computing deductible medical or moving expenses will also increase by 4.5 cents to 23.5 cents a mile, up from 19 cents for the first six months of 2011. The rate for providing services for charitable organizations is set by statute, not the IRS, and remains at 14 cents a mile.

The new rates are contained in Announcement 2011-40 on the optional standard mileage rates.

Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

Mileage Rate Changes