The Ernst & Young Tax Saver's Guide 2003

Overview

Tips and strategies on how to use the new tax law to lower your taxes

The Economic Growth and Tax Relief Reconciliation Act of 2001 has affected all taxpayers-and promises to do so for the next decade. Do you know how you're going to benefit from the new tax legislation?

When you need up-to-the-minute answers to your tax-planning questions, turn to the most reliable and authoritative source: Ernst & Young....

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Overview

Tips and strategies on how to use the new tax law to lower your taxes

The Economic Growth and Tax Relief Reconciliation Act of 2001 has affected all taxpayers-and promises to do so for the next decade. Do you know how you're going to benefit from the new tax legislation?

When you need up-to-the-minute answers to your tax-planning questions, turn to the most reliable and authoritative source: Ernst & Young.

From the authors who brought you The Ernst & Young Tax Guide-The Ernst & Young Tax Saver's Guide 2003 offers unparalleled advice and techniques that will help you lower your taxes. Packed with hundreds of unique, money-saving tips, The Ernst & Young Tax Saver's Guide 2003 gives you the lowdown on the new tax law and the best year-round strategies to save more money on your taxes.
* "Changes in the Law You Should Know About" covers the Economic Growth and Tax Relief Reconciliation Act of 2001, as well as phase-in laws that may affect future tax years
* "Tax Savers," "Tax Alerts," and "Tax Organizers" offer helpful tips and reminders
* A special life-events index helps you minimize taxes associated with marriage, home-buying, retirement, and more
* Year round tax-planning strategies and last-minute, year-end, tax-saving ideas help reduce your overall tax bill
* A special mutual fund chapter covers when to make new investments, and how to treat distributions, transfers, and redemptions
* Charts and tables clarify confusing tax issues

Plan now so you don't have to pay later. Put the experience of the nation's leading professional services firm to work for you with The Ernst & Young Tax Saver's Guide 2003.

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Product Details

  • ISBN-13: 9780471227069
  • Publisher: Wiley, John & Sons, Incorporated
  • Publication date: 10/18/2002
  • Edition description: REV
  • Edition number: 1
  • Pages: 316
  • Product dimensions: 5.40 (w) x 7.92 (h) x 0.70 (d)

Meet the Author

ERNST & YOUNG LLP is one of the nation?s leading professional services firms, providing tax, assurance, and advisory business services to thousands of individuals, as well as domestic and global businesses. Visit Ernst & Young?s Web site at wwwley.com.
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Table of Contents

How to Use This Book ix
Index to Life-Cycle Events xi
Changes in the Tax Law You Should Know About xiii
10 Smart Tax Planning Tips xix
Part I Tax Strategies for Individuals 1
1. What You Have to Include as Income 3
Introduction 3
Wages, Salaries, and Other Earned Income 3
Interest and Dividends 7
Rental Income and Expenses 11
Capital Gains and Losses 11
Selling Your Home 11
Income from Business and Other Investments 11
Social Security and Other Benefits 15
Other Income 21
2. What You Can Deduct: Exemptions, Adjustments, and Deductions 33
Introduction 33
Standard Deduction 34
Personal and Dependent Exemptions 35
Individual Retirement Arrangements (IRAs) 37
Simplified Employee Pensions 38
Keogh (HR 10) Plans 38
Simple Retirement Plans 38
Divorce or Separation 38
Medical and Dental Expenses 40
Taxes 43
Interest Expenses 44
Charitable Contributions 48
Casualty and Theft Losses 48
Moving Expenses 50
Employee Business Expenses and Other Expenses 51
Overall Limit on Itemized Deductions 56
3. Travel and Entertainment Expenses 58
Introduction 58
The 50% Deduction Limitation 58
Travel and Transportation 60
4. Tax Planning and Your Home 75
Introduction 75
Rules for Selling Your Home 75
5. IRAs, 401(k) Plans, and Other Retirement Plans 89
Introduction 89
IRAs 89
Roth IRAs 93
Coverdell Education Savings Accounts (ESAs) [Formerly Education IRAs] 95
401(k) Plans 97
Simple Plans 98
Distributions from IRAs and 401(k) Plans 99
Simplified Employee Pensions 103
Keogh (HR 10) Plans 104
Company Retirement Plans 105
6. Charitable Contributions 106
Introduction 106
Who Is the Recipient? 106
Private Foundations 109
Nondeductible Contributions 110
Gifts of Property 111
Bargain Sales 113
Limits on Deductions 113
Charitable Remainder Trusts 116
Carryovers 118
Record-Keeping and How to Report Charitable Contributions 119
Cash Contributions 119
Contributions to Charity Dinners, etc. 120
Noncash Contributions 121
7. Capital Gains and Losses 123
Introduction 123
How Capital Gains Are Taxed 123
Strategies for Selling Securities 127
Other Opportunities for Individuals 131
8. Mutual Funds 134
Introduction 134
Dividends 135
Sale of Mutual Fund Shares 141
9. Filing Status and How to Calculate Your Tax 146
Introduction 146
Who Must File 146
Filing Status 150
Citizens Living Abroad 153
Children under Age 14 155
Tax Rates for Individuals 156
Alternative Minimum Tax 156
Credits That Reduce Your Tax 161
The Hope Scholarship Credit 166
The Lifetime Learning Credit 166
Estimated Tax Payments and Withholding 168
Employment Taxes on Services by Domestic Employees 171
Penalties 172
10. Year-End Planning for Individuals 173
Introduction 173
Filing Status 175
Income 176
Adjustments and Deductions 181
Itemized Deductions 183
Part II How to Improve Your Financial Future 189
11. Investment Planning 191
Introduction 191
Getting Started 191
12. Retirement Planning 204
Introduction 204
Planning for Retirement Expenditures 204
Retirement Cash Flow and Inflation 205
Sources of Retirement Income 205
13. Estate and Gift Planning 211
Introduction 211
Getting Started 211
Estate Tax Fundamentals 212
Installment Payment of Estate Tax 231
Concerns Regarding Community Property 233
Part III Tax Strategies for Businesses 235
14. Choosing the Right Entity for Your Business 237
Introduction 237
Choosing the Proper Business Entity 237
Types of Businesses 239
15. Determining Income, Deductions, and Taxes for Your Business 245
Introduction 245
Accounting Periods and Methods 245
What to Include and What to Deduct from Income 247
How to Report Business Income 266
16. S Corporations 279
Introduction 279
Electing S Corporation Status 279
Advantages of Being an S Corporation 280
Operating as an S Corporation 282
State Tax Considerations 286
17. Year-End Tax Planning for Businesses 287
Introduction 287
Timing of Income and Deductions 287
Depreciation 288
Capital Asset Transactions 290
Charitable Giving 290
Executive Compensation 291
Dividends-Received Deduction 292
Estimated Tax Filing Requirements 292
State Tax Considerations 292
Appendices 294
Tax Calendar 299
Index 301
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First Chapter

The Ernst & Young Tax Saver's Guide 2003


John Wiley & Sons

ISBN: 0-471-22706-4


Chapter One

What You Have to Include as Income

Introduction

The first step in determining how much in taxes you'll have to pay is to figure out your taxable income. That is the amount, figured by subtracting from your gross income certain adjustments and allowable deductions, upon which your tax is based. Your gross income includes income from all sources, such as:

* Alimony and separate maintenance payments

* Compensation for services, including salary, wages, tips, fees, commissions, and certain employee benefits

* Gains from dealings in property

* Gross income from a business

* Income from an interest in an estate or trust

* Income from paying off a debt for less than you owe

* Certain income from life insurance and endowment contracts

* Interest and dividends

* Pensions and annuities

* Rents and royalties

* Court awards in noninjury or nonsickness cases (e.g., job discrimination)

* Your share of income from a partnership or S corporation, whether it is distributed or not.

This chapter discusses what you have to include in calculating your taxable income. Along the way, you'll find many tax-saving suggestions that should help you lower your taxable income-and your tax bill.

Wages, Salaries, and Other Earned Income

As a general rule, you must include in your gross income everything you receive as payment for personal services including wages, salaries,commissions, and tips. If you receive property or services as compensation, you generally should include the fair market value of the property or services as wages in the year you receive it.

Unless you anticipate a tax rate increase next year, you will generally find it to your advantage to defer recognizing income, where permissible, to a later year. Usually the date of receipt determines the year income is taxable. So, failure to cash a check or refusal to accept a payment will not defer income.

TaxAlert

The tax act signed into law in spring 2001 by President Bush includes rate reductions in 2002, 2004, and 2006.

E&Y FOCUS: Deferred Compensation Plans

Deferred compensation plans are designed by employers for executives who can afford to defer a portion of their earnings. Under such plans, you make an election to defer some portion of your income until a stated time; you are taxed on the deferred income only when it is received. Deferrals can be made from your regular salary or from bonuses. You generally should make an election to defer income before that income is earned. Furthermore, you and your employer must enter into a written deferral agreement. Deferred compensation plans serve one of two functions, depending on whether they are short-term or long-term plans: * Short-term arrangements are generally most effective when used to take advantage of tax-rate changes. For example, suppose that in the current year the top rate on your taxable income is roughly 39% (38.6%). The next year you expect your top rate to drop to 30%. You might use a deferred compensation plan to shift income from one year to the next so that it will be taxed at a lower rate. * Long-term arrangements are aimed primarily at providing key employees with bonuses and retirement income in excess of the amounts allowed by law to be provided under the employer's qualified pension and profit-sharing plans. Some experts are dubious about the benefits of long-term deferrals, mainly because they believe tax rates will be higher in the future than they are currently. If they're right, the deferred income would be taxed at a higher rate-defeating one of the primary purposes of deferring the income. It's worth noting that most deferred compensation plans include a provision for increasing the amounts deferred to reflect what you would have earned by receiving the payments up front and then investing them. Also, given the restrictions on qualified plans (plans entitled to tax-favored status), nonqualified plans continue to be popular with executives. Make Sure You Collect Your Deferred Compensation. Many traditional "nonqualified" (i.e., unfunded) deferred compensation plans are based on an unsecured promise from your employer to pay compensation in the future. But how can you be sure your company will pay up? Various arrangements have been developed to provide the employee with an additional sense of security that the promise will be honored without causing the income to be immediately taxable. One such device is known as a "rabbi trust," so named because the first arrangement approved by the IRS was developed by a synagogue for its rabbi. Under a rabbi trust arrangement, amounts sufficient to pay the deferred compensation are placed into an irrevocable trust by your employer. Once in the trust, these amounts can be accessed by the employer's creditors only upon the employer's bankruptcy or insolvency; the amounts are not otherwise available for use by the original employer or a successor employer. This means that, unless the employer becomes bankrupt or insolvent, amounts in the rabbi trust will be available to pay the deferred compensation in future years.

"Noncash" Compensation. The following are some of the more common forms of noncash compensation that are subject to tax:

1. Employer-provided automobile for personal use. If your employer provided you with a car, your personal use of the car is considered taxable noncash compensation.

2. Educational assistance. You generally must include in income any educational expenses your employer paid for you, unless the courses are required by your employer, are job-related, or the expenses are paid for under a special plan meeting IRS requirements.

3. Bargain purchase of employer's assets. If you are allowed to purchase property from your employer at a price below its fair market value as compensation for your services, you must report as income the difference between the property's fair market value and the amount you paid for it (see the exception following under "Qualified employee discount").

4. Stock options. The difference between the stock's fair market value and the option price should generally be reported as additional income when you exercise an option to buy stock from your employer. A special rule, however, applies to incentive stock options. This rule usually delays the tax until you sell or exchange your stock. (See pages 27-30 in this chapter.)

5. Group term life insurance premiums for over $50,000 of coverage. An employer's payments for group term life insurance premiums for coverage over $50,000 are considered to be additional income to you unless the beneficiary of the "over $50,000 life insurance" is an organization to which a contribution would be a charitable contribution.

6. Club memberships. If your employer provides you with a membership in a country club or similar social organization, you are subject to tax on the value of the membership.

Tax-Free Fringe Benefits. Certain fringe benefits you receive from your employer are specifically excluded from taxation. These include:

1. No-additional-cost service. If you receive services from your employer that are regularly offered for sale to customers and your employer incurs no substantial additional cost in providing them to you, you do not have to include the value of these services as income. Example: Stand-by space on flights for airline employees.

2. Qualified employee discount. You do not have to report additional income if the discount your employer extended to you is less than the discount your employer would regularly offer to customers. For the purchase of services, the discount must be less than 20% of the price regularly charged to customers. Example: Appliance retailers' discounted sales of their merchandise to their employees at the lowest discounted price offered to customers.

3. Working condition fringe benefits. You do not have to include in income the value of property or services provided to you by your employer if you would be entitled to a business deduction for such items on your personal return had you paid for these items. Example: Business periodical subscriptions.

4. De minimis fringe benefits. Fringe benefits items so small in value that it would be unreasonable or administratively impractical for your employer to account for them. Examples: Personal use of copying machine, occasional parties for employees.

5. Tax-free employee parking and transit benefits. An exclusion from gross income is allowed for an employee whose employer offers the choice between cash and parking or a transit benefit, and the employee chooses parking or a transit benefit. If the employee chooses cash, the amount offered is includible in income.

We've mentioned just a few examples. You should consult with your employer and your tax advisor to find out how to treat a particular item.

401(k) Plans. If your employer has a 401(k) plan or another plan that allows you to postpone income, you can elect to defer a certain amount of your salary on a pre-tax basis. Such amounts are withheld from your salary and are not reported as income until withdrawn from the plan. For further information about 401(k)s and other retirement plans, see Chapter 5.

TaxAlert

A key element of tax planning is reducing your income. One way to do that is to take advantage of your employer's 401(k) plan, particularly if the deductible amount you are permitted to contribute to an IRA is limited (see pages 89-93). With a 401(k), you can elect to defer up to a maximum of $11,000 in 2002 ($12,000 if you're age 50 or above). Recently enacted changes to the law increase the contribution limits in the years ahead as follows:

Individuals Individuals Under Age 50 Age 50 and Above

2003 $12,000 $14,000 2004 $13,000 $16,000 2005 $14,000 $18,000 2006 $15,000 $20,000

TAXSAVER

Although the funds in your 401(k) plan are meant to be set aside for your retirement, you may still have access to them if you need money. Your plan may permit you to borrow from the plan, subject to strict rules. Despite the restrictions, you may be better off borrowing from your retirement fund than getting a loan from your bank. If the loan from the bank is for personal purposes, it could result in nondeductible interest. While a loan from your 401(k) plan does not generate deductible interest, the interest you pay is allocated to your account (although, of course, your rate of return may be lower than what your assets were earning prior to the loan). Your best bet might be to borrow from the equity in your home. The interest on such a loan would generally be tax deductible.

Interest and Dividends

Interest that you receive on bank accounts, on loans that you have made to others, or from other sources is taxable. However, interest received on obligations of a state or one of its political subdivisions, the District of Columbia, or a possession of the United States or one of its political divisions is usually tax exempt for federal purposes. Interest paid by the IRS on a tax refund arising from any type of original tax return, if the refund is not issued by the 45th day after the later of the due date for the return (determined without regard to any extensions) or the date the return was filed, is taxable. (The interest rates on such payments are set periodically by the IRS.)

Qualified Tuition Programs

Qualified tuition programs (QTPs) are tax exempt. Gifts made to a QTP are eligible for the gift tax exclusion and the students/participants in state sponsored programs are not taxed on distributions used for qualified higher education expenses. Distributions from school sponsored programs will be tax free starting in 2004.

"Qualified higher education expenses" are tuition, fees, books, supplies, equipment required for the enrollment or attendance at a college or university (or certain vocational schools), and room and board.

TaxAlert

Under the new tax law previous restrictions on expenses for room and board have been eased.

U.S. Saving Bonds

U.S. saving bonds are direct obligations of the United States government. Three types of bonds are available: Series EE bonds, Series HH bonds, and Series I bonds. All three are subject to federal income tax, though in some circumstances (explained below) interest on Series EE and Series I bonds may be deferred for many years, and if used for certain educational purposes may even be exempt from tax. All of these bonds, however, are exempt from state and local income taxes.

Series EE Bonds. These are bonds that are issued at a discount-that is, they're purchased at a fixed amount, and are redeemed at a higher amount depending upon how long the bonds are held. Cash method taxpayers have the option of reporting income on the bonds when the bonds are redeemed or reporting it annually as it accrues. Accrual method taxpayers must report the income as it accrues.

TaxSaver

Series EE bonds can be an interesting tax-sheltered investment in two ways. First, because most individuals are cash method taxpayers paying taxes on income as it is received, interest income from Series EE bonds is not recognized until the bonds are redeemed. But, there is a second way you can shelter your interest income from Series EE bonds for an even longer time. If, instead of redeeming the bonds when they come due, you exchange them for Series HH bonds (that pay interest semiannually), you can avoid recognition of the accumulated Series EE bond interest until the Series HH bonds are redeemed.

Example: Clay purchases $7,500 worth of Series EE bonds, which pay interest of 4% per year. In slightly more than seven years, the bonds will have grown in value to $10,000. Instead of redeeming them at that point, he exchanges them for $10,000 worth of Series HH bonds, which pay interest at the rate of 4% per year. The $2,500 of interest income earned over the years on the Series EE bonds would not be taxable at the date of exchange but would be deferred. Clay will receive $400 of taxable interest income per year on the Series HH bonds.

Continues...


Excerpted from The Ernst & Young Tax Saver's Guide 2003 Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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