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Online Advisor - August 2002

For August 2002

August 15: Due date for filing 2001 individual income tax returns that received an automatic extension of the April filing deadline. If a second extension is required, Form 2688 must be filed with the IRS explaining why additional time is needed.

NOTE: Businesses are required to make federal tax deposits on dates determined by various factors that differ from business to business. Payroll tax deposits: Employers generally must deposit Form 941 payroll taxes (income tax withheld from employees' pay and both the employer's and employees' share of social security taxes) on either a monthly or semiweekly deposit schedule. There are exceptions if you owe $100,000 or more on any day during a deposit period, or if you owe $2,500 or less for the calendar quarter.

Monthly depositors are required to deposit payroll taxes accumulated within a calendar month by the fifteenth of the following month.

Semiweekly depositors generally must deposit payroll taxes on Wednesdays or Fridays, depending on when wages are paid.

For more information on tax deadlines that apply to your business, contact our office.

What's New in Taxes

New audit target: Schedule K-1 income

The IRS has a new audit target: Schedule K-1 income for partners, shareholders, and beneficiaries. According to one IRS spokesperson, the Service suspects that up to 20% of K-1 income may be underreported on individual returns.

Partnerships, trusts, and S corporations file information returns with the IRS, but generally pay no income tax. They provide owners and beneficiaries with a Schedule K-1 form, which details an individual's share of income or losses. Individuals must report Schedule K-1 income on their income tax returns.

For years, the IRS has used its computer matching program to compare income reported on W-2s and 1099 forms (wages, interest, dividends, etc.) with income reported on individual tax returns. This year the Service began using its matching program to cross check Schedule K-1 income against individual returns.

The IRS's first target is the more than 18 million Schedule K-1 forms filed for tax year 2000. As of July 9, the IRS had issued about 65,000 notices to taxpayers whose K-1 income didn't match their 2000 tax returns.

Divorce calls for tax planning

Divorce is an emotionally wrenching time when the last thing you want to think about is taxes. Yet taxes play an important role in structuring a divorce settlement, and you ignore them at your peril. A wrong decision can lead to big costs and a new source of dispute and anger.

One area where tax planning is essential is in dividing up the property. Although transfers of marital property between divorcing spouses are generally tax-free, that doesn't mean you can ignore tax considerations. For example, if you're dividing up investments, look at the cost basis as well as the market value. The spouse who gets an asset will also get the asset's cost basis and will be taxed on any gain when the asset is sold. So a spouse may be better off accepting a $70,000 investment portfolio with a cost basis of $60,000 than a portfolio valued at $80,000 with a basis of $10,000. The higher taxes payable in the second case may more than offset the difference in value.

Dividing up retirement benefits also presents tax challenges. You can split up the benefits of a qualified retirement plan without tax consequences if you obtain a qualified domestic relations order (QDRO). But even then, the rules are complex and the consequences of an error are severe. In the worst case, both spouses could be taxed on the transfer and there could also be a 10% penalty for withdrawals before age 59½. Other retirement assets such as IRAs can be transferred without a QDRO, but the transfer must still be carefully structured to avoid taxes.

Divorce, like most major life events, calls for tax and financial planning. Failure to consider tax consequences can be very costly. Contact our office if you need details or assistance in this area.

New Business

Health reimbursement arrangements get a green light from the IRS

The cost of providing health care benefits to employees can be staggering. New guidance from the IRS may make one plan, called a health reimbursement arrangement (HRA), more popular. An HRA lets an employer decide how much the business can afford to pay for health care.

Under these plans, an employer reimburses an employee's medical expenses up to a predetermined annual dollar limit. Reimbursed expenses are tax-deductible by the company and tax-free to the employee.

Until now, it was unclear whether employees could carry over any unused portion of the annual limit to increase the maximum dollar amount available the next year. Now the IRS says they can. In other words, the amount earmarked for an employee is allowed to build up tax-free to the employee. This allows employees to reserve funds for a future year when a major medical expense might occur. Retired and terminated employees can continue to draw on unused funds after they leave the company.

These employer-paid plans differ from flexible spending accounts where employees can set aside their own pre-tax dollars to pay for medical expenses. With flexible spending accounts, employees must use the amount they set aside by the end of the year or the money reverts to the employer. Some employers offer both types of plans.

Contact us if you would like more information about health reimbursement plans.

Smart Business

Does your business have a succession plan?

Regardless of what you may have heard, recent estate tax law changes haven't made business succession planning obsolete. Even if estate taxes are someday repealed for good, you will still need a succession plan. A succession plan allows your business to continue if you leave the business for any reason: your retirement, disability, death, or just your decision to move on.

Here are some basic steps you should take to help ensure the survival of your business.

Determine who will succeed you. Will it be family members, your business partners, your employees, or an outside buyer? Each choice requires a different plan.

Prepare a timeline. Barring death or disability, when and how do you plan to exit the business? Well in advance of your planned departure, equip your successors with the skills and experience necessary to take over.

Maintain complete and accurate financial records. Your company's financial history is essential to preparing a fair business valuation. An accurate valuation is important for several reasons. First, you deserve a fair price for your business. Second, a buyer and his creditors will want evidence that the purchase price is fair. Finally, your company's valuation may have to withstand IRS scrutiny.

Create a financing plan. Your plan might include life and disability insurance, an employee stock ownership plan, or a stock redemption plan. Whatever your plan, it should take your future financial needs into account and provide a method for your successors to meet those needs.

Surround yourself with a team of advisors. Your accountant, your attorney, your banker, and your insurance agent can each have an important role to play in completing your plan.

Failure to plan for an orderly transition can result in financial losses or even the loss of your business. A well-designed plan, on the other hand, can protect your family, your employees, your co-owners, and your customers. Call us for assistance in setting up a succession plan for your business.

What's New in Financial Strategies

Congress and the SEC act to restore investor confidence

Shortly before adjourning for its August recess, Congress passed landmark legislation aimed at combating corporate fraud and restoring the public's trust in corporate America.

The new law includes provisions that:
* Require chief executive officers and chief financial officers to sign financial reports.
* Lengthen potential prison terms for individuals who commit corporate fraud and play a part in document destruction.
* Create an accounting oversight board that is independent of the accounting industry.
* Bar auditors of public companies from performing certain consulting services for their audit clients.
* Prohibit executives from trading company stock during blackout periods set by employee retirement plans.
* Ban certain loans to executives.
* Give the SEC more authority and a bigger budget.

To help restore investor confidence, the Securities and Exchange Commission (SEC) recently ordered the executives at 947 of the largest publicly traded companies to swear by their numbers. The names of these companies appear on an SEC list at ( Under the SEC order, both the company's chief executive officer and chief financial officer must personally certify that company reports filed with SEC are both complete and accurate. Officers who make false certifications will face civil and criminal penalties.

Are your bank accounts insured?

How safe are your bank accounts? You probably rely on FDIC (Federal Deposit Insurance Corporation) insurance to protect your money if your bank fails. But this might be a good time to check your FDIC coverage for several reasons.

First, you might have less insurance coverage than you think. If your savings and loan or bank is an FDIC member, you've probably noticed the FDIC logo that says "each depositor insured to $100,000." A common misconception is that every account is insured up to $100,000. Unfortunately, it's not that simple. For example, a $100,000 insurance limit applies to the combined total of all accounts that are in your name alone. If you have $10,000 in checking, $20,000 in passbook savings, and $90,000 in bank CDs, FDIC insurance covers only $100,000 of your total $120,000. Similar limits apply to your share of all joint accounts and your combined IRA accounts.

A second reason to be cautious is that not all products you buy at the bank branch are FDIC insured. Many banks sell investment products, such as annuities and mutual funds. FDIC protection only applies to traditional deposit accounts, such as checking, savings, certificates of deposit, and money market deposit accounts. In addition, your bank must be an FDIC member in order for you to have FDIC protection.

Finally, although the banking industry is generally safe and bank failures are rare, they do happen. The FDIC was created in 1933 to insure deposits and to promote sound banking practices. According to the FDIC, the number of thrifts and banks on their "problem" list has grown in 2002.

By knowing and following the FDIC insurance rules, you can avoid unnecessary exposure to risk. It could be well worth your time to sit down with a bank representative and review the FDIC insurance coverage on each of your bank accounts.

Chuckle of the Month

Have you ever been asked to write a recommendation for a job candidate for whom you don't have anything good to say? The following suggestions might come in handy.

* For a person who doesn't get along well with others: I am pleased to say this person is a former colleague of mine.

* For a person who is lazy: In my opinion, you will be very fortunate to get this person to work for you.

* For a person who is a criminal: He is a man of conviction.

* For an untrustworthy person: Her true ability is deceiving.

* For an unskilled worker: I most enthusiastically recommend this person with no qualifications whatsoever.

The information contained in this site is of a general nature and should not be acted upon in your specific situation without further details and/or professional assistance. For more information on anything in the ONLINE ADVISOR, or for assistance with any of your tax, business, or financial strategy concerns, contact our office.

Copyright 1998 Richard C. Woodbury P.C. CPA