Tax Planning – Do It Now!

Worcester Jewish Chronicle, November 18, 2004

Tax Planning – Do It Now!

William E. Philbrick, CPA, MST, CVA

The key to substantial tax savings is timely tax planning. This applies equally to all taxpayers. Each dollar saved can be used to meet your personal and business financial goals. Timely planning allows you to take advantage of favorable tax provisions and at the same time avoid costly pitfalls.

Too many individual taxpayers’ idea of planning is to hunt for evidence of deductions before they file their annual tax return. This is too late, as their tax year has closed and they are limited to what happened in the closed year with certain limited exceptions such as IRA and Keogh plan contributions made after year-end.

It is critical to do the planning and take appropriate action before the close of the tax year. While we will discuss some of the basic tax-planning rules from the viewpoint of the individual, they are applicable to businesses as well.

Timing is everything with the reporting of income and the claiming of deductions and credits. The basic rule is to be able to report your income when you are in a lower tax bracket and claim your deductions and credits when you are in a higher tax bracket.

If you expect to be in a lower bracket in 2004 than in 2005, you would want to accelerate income for 2004 and defer deductions and credits until 2005. On the other hand, if your tax bracket is stable, timing is still critical.

Assume that you expect to be in the 15 percent bracket for 2004 and 2005 but want to remodel your kitchen. You plan to make a qualified withdrawal of $50,000 from your IRA to pay for the new kitchen. If you take the money in one lump sum, you will push yourself into the 25 percent bracket.

By splitting the withdrawal between the two years, you will be able to take maximum advantage of the lower rates, saving real money, and avoid or postpone the higher rate for at least a year.

Recognizing income in a lower bracket, claiming deductions and credits in a higher bracket and postponing the tax whenever possible are the keys to successful planning. However, your tax bracket can be influenced and affected by other factors.

Your individual tax bracket is affected by your filing status. Married taxpayers file either using married filing jointly (MFJ) or married filing separately (MFS). While the MFJ schedule will usually produce a lower tax result, there are unusual circumstances where MFS will be a benefit.

Single taxpayers generally file using single status unless they qualify for head-of-household (HOH) status. To claim HOH status, a single person must generally live with and provide support for a dependent.

The HOH rates are lower than the rates for single status but are not as favorable as MFJ rates. As your filing status is determined as of the last day of your tax year, marriage, divorce and qualified dependents play a critical role.

Another key factor that affects your tax bracket is your income level. Swings in income from one year to another can result from a variety of circumstances and events.

Divorce, marriage, death, job changes, retirement, illness, cash windfalls, sales of assets such as stock or a residence or business, and business startups can produce dramatic impacts on your income and present unique tax-planning situations that you may be able to take advantage of with timely planning.

Once you have made a careful analysis and taken all of your circumstances into consideration and planned to maximize your planning opportunities by deferring income to a lower bracket year, claiming your deductions and credits in a higher bracket year or spread income and deductions over more than one year fully utilizing your filing status, you are not done.

A key critical factor you will need to address is the alternative minimum tax (AMT). Failure to properly plan for the impact of the AMT may see all of your efforts to effectively plan crash and burn.

The AMT was originally enacted to provide that taxpayers pay a minimum amount of tax. It was targeted at high-income taxpayers who took advantage of planning opportunities to eliminate all their tax.

However, as the AMT is not adjusted for inflation, more and more middle-income taxpayers are finding they are liable for this tax, which may very well put them in a higher tax bracket than they had planned on. It has been estimated by the Joint Committee on Taxation that without any legislative intervention, the number of taxpayers subject to AMT will grow from 1 million taxpayers in 2000 to over 17 million on 2010.

The AMT is a complex calculation. It treats certain tax breaks and deductions as “tax preferences” and either modifies or eliminates the “preferences” in the calculation. The very nature of the AMT is counterintuitive. Thus you may not receive any tax benefit for the deductions you planned to claim in the higher tax bracket year.

There are still tax-planning opportunities to minimize the impact of the AMT on your effective tax bracket, particularly when you are subject to the AMT in one year and not another, further adding to the complexity of the planning process.

As you can see, timely planning should not be a last-minute effort, and you will probably need the advice of a knowledgeable tax adviser to take advantage of all your tax saving opportunities and avoid the pitfalls. Your number one rule should be “Do it now!”

 

 * * * * *

William E. Philbrick, CPA, MST, CVA, CFF is a Senior Vice President and Director of Taxes and Forensic Services with Greenberg Rosenblatt Kull &Bitsoli, P.C. of Worcester, Mass. He can be reached at wphilbrick@GRK&B.com.

Study to shed light on ‘gray economy’ of misclassified workers

Worcester Business Journal – October 18, 2004

Study to shed light on ‘gray economy’ of misclassified workers

MICKY BACA

For decades, unscrupulous construction contractors, as well as employers in other industries, have dodged paying workers compensation, unemployment insurance and other mandated payroll expenses by misclassifying workers as independent contractors. Now researchers at Harvard University are conducting a study to find out how widespread the practice is and how much it is costing in lost state and federal revenue, worker hardships and unfair competition to legitimate contractors.

 While the results are expected to have significance for those on all sides of the construction labor market, general contractors have added incentive to monitor the outcome after a recent state Superior Court ruling upped their potential liability by allowing a misclassified worker of a subcontractor to sue the general contractor for damages if the worker is injured on the job site.

 The study is taking place as construction union officials contend misclassification of workers in on the rise in the region and as the state’s Attorney General’s office has vowed to make prosecution of misclassification a priority in the wake of new state laws clarifying regulations.

 How it works

Here’s an illustration of how misclassification works: Drywall subcontractor X has been hired to work on an area housing project. It has workers report to the job at a prescribed time and supplies them with tools, materials and direction.  But X doesn’t list the workers as employees. Instead, it deems them “independent contractors,” who, among other things, must take care of their own workers compensation, unemployment insurance, social security and other workers benefits.

 With no deductions and an opportunity to under-report income, the workers may get more money in their paychecks, but they lose out on overtime, health insurance and unemployment benefits if they are laid off. Company X, in turn, saves as much as 20 to 30 percept in payroll expenses it would have incurred if it paid the “independent” workers like regular employees.

 So goes the “gray economy” of misclassifying workers in the construction industry, an illegal practice that industry leaders and regulators admit is tough to quantify, even tougher to enforce and could have far-reaching ramifications for workers, taxpayers and the construction industry overall. 

Offloading private problems to the public purse

The study is being done by the Construction Policy Research Center, a research and public policy group that is a collaboration of the Harvard School of Public Health, the Harvard Law School’s Labor and Worklife Program, according to Elaine Bernard, executive director of the Labor and Worklife Program. The issue of misclassifying workers was brought to the program’s attention by the various groups, Bernard says, including the Boston-based N.E. Regional Council of Carpenters, who see the practice as a growing problem in the region.

 From six percent to 20-25 percent of employers misclassify workers, depending on the state and the industry, says researcher Francoise Carre of the McCormack School, UMass-Boston. 

While misclassification is a major concern of unions because it undermines their organization of workers, Bernard says the practice hurts those on all sides of the construction labor world. “It’s an interesting situation, where workers and companies are harmed and the government is harmed,” she says. “A number of individuals and institutions are taking advantage…by offloading the cost of their failure to comply onto everybody else.”

 When companies, don’t pay their share of workers comp, Bernard notes, other companies must pickup the slack. Workers who become disillusioned with being classified as subcontractors have difficulty changing back to being classified as employees because they could be liable for back taxes, she says. And if an uninsured worker is injured, the cost of their care often gets transferred to the public purse. Bernard says. What’s more, other subcontractors bidding on the same work as those who misclassify workers are at a decided pricing disadvantage, she says.

 General contractors, under which unscrupulous subcontractors may work, also have a stake in the misclassification dilemma – that got even higher with the recent court ruling, notes James Grosso, legal council for the Associated General Contractors of Mass. Labor Relations Division. Not only are they potentially liable for illegal actions on their job sites, but general contractors are also required to pay worker comp benefits to workers (misclassified or not) of subcontractors when such workers are injured on their job site and the sub has no workers comp insurance. The Sept. 14, 2004 ruling extended the general contractors’ potential liability in such cases even further when it determined that an uninsured masonry worker, Daniel Larson, is entitled to sue Burlington-based general contractor Fred Salvucci Corp. for damages even though Salvucci paid workers comp benefits for Larson’s injuries on the job. Larson was a worker for Methuen-based subcontractor Great Eastern, which did not provide workers comp insurance for him, according to the suit.

 In a traditional employee relationship, Grosso says, when an employer provides workers comp insurance, that company cannot be sued by the worker for damages. While Larson was not listed as a misclassified worker in the court decision, Grosso says the ruling certainly ups general contractors’ exposure in misclassification cases.

 A reliable source

Grosso says misclassification of workers isn’t a top concern of AGCM but it is a concern. He says he thinks the Harvard study is a good idea to quantify just how big a problem the practice is. Grosso says he is confident that a study of the issue by Harvard will be balanced. He says he would be “suspicious” of such a study if it were done by a less reputable researcher with links to labor unions.

 The misclassification issue is a key focus of the N.E. Regional Council of Carpenters, which sees it as a growing problem in the construction labor market and seeks to publicize alleged violations by contractors. Stephen Joyce, research director for the union’s labor management program, say the practice is “rampant” and isn’t just a threat to the union but is harmful to workers, companies and taxpayers. Some contend, however, the union uses the issue in its effort to discredit contractors who aren’t committed to using union labor.

 One contractor dogged by the carpenters union for allegedly using questionable subcontractors because, its owner says, it has not agreed to sign a contract with the union, is Worcester-based Cutler Associates Inc. Cutler CEO Frederic Mulligan says that, while he is not familiar with the Harvard study, he thinks it would be helpful if the issue of misclassification of workers could be clarified.

 Mulligan says there’s a lot of confusion about who can be classified as an independent contractor. “The problem from my view is that it is so unclear,” he says, noting that state and federal guidelines vary. “If there were more clarity, it would benefit the companies trying to do it right,” he adds.

His company, he says, does the right thing, has never had a claim against it for misclassification and hasn’t had any violations by subcontractors on its work sites.  He says some subcontractors his company uses have been cited but found innocent.

 “It’s real, real easy to fall into the trap,” says William Philbrick of Greenberg, Rosenblatt, Kull & Bitsoli.  The savings a company can realize from misclassifying workers as independent subcontractors can be up to 30-3 percent.

 This could happen to you

Bill Philbrick, director of tax and business valuation services at Worcester-based accounting firm Greenberg, Rosenblatt, Kull & Bitsoli, agrees that the distinction between who is a valid independent contractor and an employee is a complex one about which companies need to be careful. In some cases, he says, a company may have crossed the line between using someone as an employee instead of a subcontractor and not even realize it.

 For example, he notes, a general contractor who has long done business with a particular subcontractor that also works for other jobs may not realized that, if the relationship changes to the point where that subcontractor only does work for that general contractor and begins to take direction from them, they have become an employee.

 Straying into misclassifying workers can have tremendous financial repercussions for companies, Philbrick says. If a company hires a worker as a subcontractor and has other employees who have tax-exempt pension and benefits plans and is found by the IRS to have misclassified that one subcontractor, the IRS could declare the benefits program invalid because it wasn’t offered to all employees. In such a case, he says, the IRS could revoke the tax-exemption status of all other employee benefits. Such a ruling could bankrupt a company, according to Philbrick.

 Philbrick cautions that when it comes to independent contractors, companies should seek professional advice. “It’s real, real easy to fall into the trap,” he says. On the other hand, Philbrick says, the savings companies can enjoy from misclassifying workers as independent subcontractors are substantial, as much as 30-35 percent. “Let me put it this way, it’s very tempting,” he says.

 “The problem from my view is that it is so unclear,” says Frederick Mulligan, CEO of Cutler Associates, on varying state and federal guidelines for classifying employees.  “If there were more clarity, it would benefit the companies trying to do it right.”

 In a nutshell

•  Worker misclassification, which researchers and union officials speculate is on the rise in the region, is the practice by which companies can save between 20 and 30 percent on labor costs by listing employees as “independent contractors” rather than as employees.

•  But treating an independent contractor in the same manner as employees can have significant financial repercussions, such as loss of tax benefits for pension plans and, in the case of a recent state Superior Court ruling, allowing a misclassified worker to sue the general contractor for damages if the worker is injured on the job site.

•  A Harvard study is seeking to establish patterns of subcontracting practices in New England to enable researchers to estimate how much misclassification may be occurring. Researchers are using unemployment insurance data but they don’t have access to information on specific companies or individuals. The study is expected to be finished next spring.

•  The state Attorney General’s office says new laws have clarified misclassification and that the office expects to prosecute more violators.

Taxing Decision Bush, Kerry present stark decisions for America’s electorate

Telegram and Gazette • October 17. 2004 7:20AM

Taxing Decision Bush, Kerry present stark decisions for America’s electorate

By Jim Bodor TELEGRAM & GAZETTE STAFF

During a campaign stop in New Hampshire in February 1988, then-candidate George H.W. Bush made an infamous pledge: "Read my lips: No new taxes," he said.

He repeated the pledge at various events in the next few months, making it a mantra of his run for the presidency.

Two years later, on June 26, 1990, faced with a growing deficit and a sluggish economy, then-President Bush issued a statement calling for, among other things, "entitlement reform, tax revenue increases and discretionary spending reductions."

The media immediately pounced on the statement as a reversal of Mr. Bush’s earlier promise. Two years later, it was widely regarded as one of the top reasons why Mr. Bush lost the presidency after one term to a youthful Arkansas Democrat named Bill Clinton.

The episode stands as a reminder of why taxation is one of the touchstone issues for American voters, the kind of singular issue that can determine the outcome of an election in a blink.

This year, both voters and the candidates have been more preoccupied with the issues of terrorism and the wars in Iraq and Afghanistan. But taxation continues to run a close second to those issues, taking up long stretches of the candidates’ televised debates and leading to some of the most heated exchanges between Sen. John F. Kerry, D-Mass., and President George W. Bush.

It’s also an issue on which the two candidates diverge widely.

The president wants to make permanent all of the lower tax rates established with the 2003 Jobs and Growth Tax Relief Reconciliation Act, including the 15 percent tax rate on dividends and most long-term capital gains. Most of those tax breaks were passed with "sunsets," dates when they will expire.

Mr. Kerry wants to return the top two tax brackets to Clinton-era levels, by raising the 35 percent bracket to 39.6 percent, and the 33 percent bracket to 36 percent. This is the proposal behind his pledge to raise taxes "only on Americans who earn more than $200,000 per year." According to a review of 2001 tax returns by Bloomberg News, 2.2 million households would be affected by that proposal.

He also wants to allow the tax rate on dividends to return to as much as 39.6 percent, and to increase the tax rate on most long-term capital gains from 15 percent to 20 percent.

"People vote looking backward and forward," said Chris Edwards, director of tax policy for the Cato Institute "If they think Bush’s tax cuts were reckless, that’ll be a boost for Kerry. If they have made money in the stock market and like paying lower taxes on dividends and capital gains, they’ll support Bush."

Mr. Kerry proposes the creation of $177 billion in new health care tax credits for small businesses, as well as another $142 billion in tax credits for manufacturers that hire new employees. He also supports lowering the corporate tax rate by 5 percent.

The president argues that maintaining the tax breaks passed during 2003 will help small-business owners, many of whom report their business income on their personal income taxes, putting them in the top two upper tax brackets Mr. Kerry is targeting. About 900,000 Americans are small-business owners who would be affected by Mr. Kerry’s proposal, according to President Bush.

Democrats argue that the president’s figures, which are based on the type of tax form used by less than 20 percent of small-business owners, are misleading because many wealthy Americans use the same form to record income they receive from passive investments, such as real estate.

"The administration is seriously exaggerating the benefits of its tax cuts to the vast majority of small businesses," said Joel Friedman, a tax policy analyst at the Center on Budget and Policy Priorities, a Washington, D.C., research institute that studies state and federal budget policies. "The fact is that those benefits will flow disproportionately to business owners with high incomes or large accumulations of wealth."

Both candidates support the continued elimination of the so-called "marriage penalty," which before 2003 required married couples to pay more in taxes than two single people earning the same amount of money.

Either candidate, if elected, may struggle to pay for his proposal, said Timothy J. Rupert, associate professor of taxation at Northeastern University.

"I’ve read through what both of them plan and I’m not sure either one is a real viable plan, given the deficit concerns," he said. "Congress has given taxpayers a lot of tax breaks, which can have a positive impact on the economy, but has given them with sunsets, which tells you we really can’t pay for them."

Mr. Bush’s proposals may increase the $413 billion federal deficit, he said. Mr. Kerry’s proposals may not generate enough money to fund the efforts he supports, he said.

"Mr. Kerry is talking about targeting high-income taxpayers," he said. "But we did that in 1993, and the question then and now is, ‘Will it generate enough revenue?’ "

Earlier this week, a group of 368 economists, including six Nobel laureates, raised similar issues about Mr. Kerry’s proposals, saying his elimination of the tax cuts for the wealthiest families would jeopardize U.S. growth.

In August, the Kerry campaign released a similar letter from 10 Nobel Prize-winning economists calling Mr. Bush’s economic policies "reckless and extreme."

Some Worcester County small-business owners said they think Mr. Kerry’s tax proposals could hurt them.

Robb B. Ahlquist, owner, along with his wife, Madeleine, of the One Eleven Chop House and the Sole Proprietor restaurants in Worcester, said he fears that increasing taxes on small-business owners will prevent reinvestment in those businesses and the hiring of new employees.

"When you have to pay higher taxes, it definitely affects how you run your business," he said. "I’m much more comfortable making my own decisions about my money than having the government make decisions about it. We reinvest heavily in our businesses when we can."

Small-business owners who make more than $200,000 annually are the entrepreneurs who keep the economy growing, said Bruce A. Taylor, president of ERA Key Realty Services of Milford, a real estate company that has Central Massachusetts offices in Spencer, Worcester, Oxford, Whitinsville and Westboro.

"When you give those top earners a tax cut, they don’t eat that money," he said. "They invest it, which multiplies itself throughout the economy. When you give those people more disposable income, they invest it. I personally think the only reason the economy did not go into a deeper recession was because of those tax cuts."

Not all business leaders are behind Mr. Bush’s economic policies, however.

Peter S. Cohan of Marlboro, a former venture capitalist and author of several books about technology business trends, has joined forces with a group called Business Leaders for Kerry. The group, which includes billionaire investor Warren Buffett and Apple Computer founder Steve Jobs, has publicly stated its support for Mr. Kerry’s fiscal policies and are supporting his campaign.

Mr. Cohan has never gotten so directly involved in politics before, he said, but was motivated by his deep concerns about the federal deficit and the drag he believes that is placing on the stock market and the economy.

"The ultimate difference between the two is that the Kerry campaign talks about how to pay for what it proposes," he said. "I actually think Kerry is more concerned about deficit reduction, and Bush is more concerned about cutting taxes and doesn’t care about the deficit. Kerry believes it’s more important to bring the budget back into balance."

The deficit, increases in energy costs and the threat of terrorism have sapped the economy of its energy, Mr. Cohan contends.

"The economy is not doing as well as it should be for an economy coming out of a recession," he said. "A lot of costs are going up, and income is going down."

Some observers say that when it comes to taxes, it makes no difference which candidate is elected. Congress determines which tax packages pass, often making dozens of amendments and changes to the proposals as they move along, they said. Republicans currently hold a majority in both the House and the Senate.

"The truth of the matter is, they can rail away at each other, but Congress makes tax policy," said William E. Philbrick, senior vice president of the accounting firm Greenberg, Rosenblatt, Kull & Bitsoli of Worcester.

Whichever candidate wins also will have to deal somehow with the federal deficit, said Mr. Philbrick, who is a certified public accountant and writes a weekly e-mail newsletter about tax topics. That is likely to hinder any new proposals, he said.

"Bottom line, somebody’s going to have to deal with the deficit," he said. "They’ve got all these ideas, but we’re in a terrible deficit situation."

Business Reporter Jim Bodor can be reached at jbodor@telegram.com.

 

Tales of Tax Fraud Are a Hoot, but the Penalties Are No Joke

The Washington Post – April 1, 2004; Page E03

Tales of Tax Fraud Are a Hoot, but the Penalties Are No Joke

Michelle Singletary

For decades, unscrupulous construction contractors, as well as employers in other industries, have dodged paying workers compensation, unemployment insurance and other mandated payroll expenses by misclassifying workers as independent contractors. Now researchers at Harvard University are conducting a study to find out how widespread the practice is and how much it is costing in lost state and federal revenue, worker hardships and unfair competition to legitimate contractors.

 While the results are expected to have significance for those on all sides of the construction labor market, general contractors have added incentive to monitor the outcome after a recent state Superior Court ruling upped their potential liability by allowing a misclassified worker of a subcontractor to sue the general contractor for damages if the worker is injured on the job site.

 The study is taking place as construction union officials contend misclassification of workers in on the rise in the region and as the state’s Attorney General’s office has vowed to make prosecution of misclassification a priority in the wake of new state laws clarifying regulations.

 How it works

Here’s an illustration of how misclassification works: Drywall subcontractor X has been hired to work on an area housing project. It has workers report to the job at a prescribed time and supplies them with tools, materials and direction.  But X doesn’t list the workers as employees. Instead, it deems them “independent contractors,” who, among other things, must take care of their own workers compensation, unemployment insurance, social security and other workers benefits.

 With no deductions and an opportunity to under-report income, the workers may get more money in their paychecks, but they lose out on overtime, health insurance and unemployment benefits if they are laid off. Company X, in turn, saves as much as 20 to 30 percept in payroll expenses it would have incurred if it paid the “independent” workers like regular employees.

 So goes the “gray economy” of misclassifying workers in the construction industry, an illegal practice that industry leaders and regulators admit is tough to quantify, even tougher to enforce and could have far-reaching ramifications for workers, taxpayers and the construction industry overall. 

Offloading private problems to the public purse

The study is being done by the Construction Policy Research Center, a research and public policy group that is a collaboration of the Harvard School of Public Health, the Harvard Law School’s Labor and Worklife Program, according to Elaine Bernard, executive director of the Labor and Worklife Program. The issue of misclassifying workers was brought to the program’s attention by the various groups, Bernard says, including the Boston-based N.E. Regional Council of Carpenters, who see the practice as a growing problem in the region.

 From six percent to 20-25 percent of employers misclassify workers, depending on the state and the industry, says researcher Francoise Carre of the McCormack School, UMass-Boston. 

While misclassification is a major concern of unions because it undermines their organization of workers, Bernard says the practice hurts those on all sides of the construction labor world. “It’s an interesting situation, where workers and companies are harmed and the government is harmed,” she says. “A number of individuals and institutions are taking advantage…by offloading the cost of their failure to comply onto everybody else.”

 When companies, don’t pay their share of workers comp, Bernard notes, other companies must pickup the slack. Workers who become disillusioned with being classified as subcontractors have difficulty changing back to being classified as employees because they could be liable for back taxes, she says. And if an uninsured worker is injured, the cost of their care often gets transferred to the public purse. Bernard says. What’s more, other subcontractors bidding on the same work as those who misclassify workers are at a decided pricing disadvantage, she says.

 General contractors, under which unscrupulous subcontractors may work, also have a stake in the misclassification dilemma – that got even higher with the recent court ruling, notes James Grosso, legal council for the Associated General Contractors of Mass. Labor Relations Division. Not only are they potentially liable for illegal actions on their job sites, but general contractors are also required to pay worker comp benefits to workers (misclassified or not) of subcontractors when such workers are injured on their job site and the sub has no workers comp insurance. The Sept. 14, 2004 ruling extended the general contractors’ potential liability in such cases even further when it determined that an uninsured masonry worker, Daniel Larson, is entitled to sue Burlington-based general contractor Fred Salvucci Corp. for damages even though Salvucci paid workers comp benefits for Larson’s injuries on the job. Larson was a worker for Methuen-based subcontractor Great Eastern, which did not provide workers comp insurance for him, according to the suit.

 In a traditional employee relationship, Grosso says, when an employer provides workers comp insurance, that company cannot be sued by the worker for damages. While Larson was not listed as a misclassified worker in the court decision, Grosso says the ruling certainly ups general contractors’ exposure in misclassification cases.

 A reliable source

Grosso says misclassification of workers isn’t a top concern of AGCM but it is a concern. He says he thinks the Harvard study is a good idea to quantify just how big a problem the practice is. Grosso says he is confident that a study of the issue by Harvard will be balanced. He says he would be “suspicious” of such a study if it were done by a less reputable researcher with links to labor unions.

 The misclassification issue is a key focus of the N.E. Regional Council of Carpenters, which sees it as a growing problem in the construction labor market and seeks to publicize alleged violations by contractors. Stephen Joyce, research director for the union’s labor management program, say the practice is “rampant” and isn’t just a threat to the union but is harmful to workers, companies and taxpayers. Some contend, however, the union uses the issue in its effort to discredit contractors who aren’t committed to using union labor.

 One contractor dogged by the carpenters union for allegedly using questionable subcontractors because, its owner says, it has not agreed to sign a contract with the union, is Worcester-based Cutler Associates Inc. Cutler CEO Frederic Mulligan says that, while he is not familiar with the Harvard study, he thinks it would be helpful if the issue of misclassification of workers could be clarified.

 Mulligan says there’s a lot of confusion about who can be classified as an independent contractor. “The problem from my view is that it is so unclear,” he says, noting that state and federal guidelines vary. “If there were more clarity, it would benefit the companies trying to do it right,” he adds.

His company, he says, does the right thing, has never had a claim against it for misclassification and hasn’t had any violations by subcontractors on its work sites.  He says some subcontractors his company uses have been cited but found innocent.

 “It’s real, real easy to fall into the trap,” says William Philbrick of Greenberg, Rosenblatt, Kull & Bitsoli.  The savings a company can realize from misclassifying workers as independent subcontractors can be up to 30-3 percent.

 This could happen to you

Bill Philbrick, director of tax and business valuation services at Worcester-based accounting firm Greenberg, Rosenblatt, Kull & Bitsoli, agrees that the distinction between who is a valid independent contractor and an employee is a complex one about which companies need to be careful. In some cases, he says, a company may have crossed the line between using someone as an employee instead of a subcontractor and not even realize it.

 For example, he notes, a general contractor who has long done business with a particular subcontractor that also works for other jobs may not realized that, if the relationship changes to the point where that subcontractor only does work for that general contractor and begins to take direction from them, they have become an employee.

 Straying into misclassifying workers can have tremendous financial repercussions for companies, Philbrick says. If a company hires a worker as a subcontractor and has other employees who have tax-exempt pension and benefits plans and is found by the IRS to have misclassified that one subcontractor, the IRS could declare the benefits program invalid because it wasn’t offered to all employees. In such a case, he says, the IRS could revoke the tax-exemption status of all other employee benefits. Such a ruling could bankrupt a company, according to Philbrick.

 Philbrick cautions that when it comes to independent contractors, companies should seek professional advice. “It’s real, real easy to fall into the trap,” he says. On the other hand, Philbrick says, the savings companies can enjoy from misclassifying workers as independent subcontractors are substantial, as much as 30-35 percent. “Let me put it this way, it’s very tempting,” he says.

 “The problem from my view is that it is so unclear,” says Frederick Mulligan, CEO of Cutler Associates, on varying state and federal guidelines for classifying employees.  “If there were more clarity, it would benefit the companies trying to do it right.”

 In a nutshell

•  Worker misclassification, which researchers and union officials speculate is on the rise in the region, is the practice by which companies can save between 20 and 30 percent on labor costs by listing employees as “independent contractors” rather than as employees.

•  But treating an independent contractor in the same manner as employees can have significant financial repercussions, such as loss of tax benefits for pension plans and, in the case of a recent state Superior Court ruling, allowing a misclassified worker to sue the general contractor for damages if the worker is injured on the job site.

•  A Harvard study is seeking to establish patterns of subcontracting practices in New England to enable researchers to estimate how much misclassification may be occurring. Researchers are using unemployment insurance data but they don’t have access to information on specific companies or individuals. The study is expected to be finished next spring.

•  The state Attorney General’s office says new laws have clarified misclassification and that the office expects to prosecute more violators.

Getting Your Financial House In Order Is A Must

Worcester Jewish Chronicle, March 24, 2004

Getting Your Financial House In Order Is A Must

William E. Philbrick, CPA, MST, CVA, CFF

Ever tear your bedroom apart looking for that birth certificate; sure you had safely stashed it in your sock drawer? Or pulled an all-nighter organizing your tax records after spending the previous three days looking for documents and receipts? If you have, this information will help you gain control of your financial house.

Whether you are a pack rat, saving every piece of paper in the first draw or shoe box you find or the laissez faire filer, who saves some and discards some, depending on your mood, you’ll be left scrambling when you actually need to find an important document.

The time and effort to organize your financial records pays off in more ways than less frustration. First, organized records will make your tax preparation easier and less time consuming. Complete tax records will help remind you of deductions you might otherwise overlook and they come in handy if the IRS questions your return, helping to avoid interest, penalties, or additional taxes. Second, good records will give you a better handle on your overall financial situation and help your CPA identify financial and tax-planning opportunities. Lastly, should you die or become incapacitated, a well-organized records system will ease the burden on your loved ones by providing a road map to your financial affairs.

To get started, begin at your local office supply store and pick up the items you need to start your filing system such as hanging files and manila folders, as well as a container to keep them in. If you prefer to keep electronic records, many software systems allow you to download electronic statements. You can help on space by scanning documents onto your computer. Make sure to keep a backup file in case your computer is ever damaged or destroyed. Don’t forget to get a quality paper shredder, more identity theft occurred last year from non-online sources than from the Internet. Discarded documents in the trash are prime sources for personal information.

You should divide your records into three categories. First are “current” files that you will be adding to through the year. Be sure they are located in a convenient location. Now find a spot for “dead” files. This is information you need to keep but won’t have to access often. A safe out of the way space, which is dry, will work for this purpose. The third category is your safe-deposit box. It is where you will keep documents that are costly or difficult to replace, like wills, deeds and car titles.

Now you need to sort that pile. What do you keep and what do you discard? While your personal circumstances will dictate your needs, consider six universal subject areas- taxes, banking, investments, retirement plans, insurance policies and your home for starters.

Starting with taxes, maintain a current file for this year’s return. Include all your income information and backup documentation for deductions, including receipts and cancelled checks. Add your past year’s return to this file. All other returns and related documents can be moved to the “dead” storage area. Plan to keep the prior year returns for six to ten years to be safe you are beyond the period the IRS has to question your return.

Banking records can take up a large part of your system. Keep separate files for each account for the current year and compare them to your 1099s at the end of the year. If they agree, discard the statements. After a year, you can discard cancelled checks except for those that support tax deductions and tax payments. Pull these and put them with your current tax file. Also keep cancelled checks that relate to a home purchase, capital improvements to your home, investments, and non-deductible IRA contributions.

Investment records files need to be maintained so you will have the documentation to establish your cost basis. Failure to do this could result in double tax. For example, reinvested dividends are currently taxable, but add to your cost basis when you sell.

Plan on holding your investment records a minimum of three years after the sale.

Set up a separate file for each retirement plan that you have. Each file should include enrollment papers, statements, a list of beneficiary designations and contact information.

This information will be very important if you have IRAs, which have contributions, which were made with pre-tax and post-tax income. You can avoid being taxed on the non-deductible contributions when you start to withdraw, if you maintain these files.

Your insurance record keeping is fairly simple. Make a file for each policy with the policy number, insurance company name, your agent’s name, what is covered and any beneficiaries. Imagine the ease of filing a claim with all these details at your fingertips.

If you own a home, set up a file on the purchase of your home. Next add a file on all improvements and additions. While there is a $250,000 exclusion on the sale gain, double if you are married. Don’t count on that to excuse keeping the records, as inflation can drive up prices and what Congress has given, Congress can take away.

Also set up an inventory file on your belongings. Include brand, model and serial numbers, purchase prices and replacement costs for big-ticket items. Photos or videos of your property are invaluable in the event of an insurance claim. Make copies of the inventory list, photos and video for your safe deposit box in case your home is damaged or burglarized.

If you don’t have a safe deposit box, rent one. It should contain personal records such as birth and marriage certificates, as well as adoption, citizenship and divorce papers. You also should have your proof of ownership for major possessions such as real estate, autos, boats, as well as stock or bond certificates. Again, while these can all be replaced, but not without a lot of time and effort.

You should also store your signed, original will in your safe deposit box. But you should also keep a copy at home and an additional copy with your attorney. Old originals and copies should be destroyed if you make any changes to avoid any confusion after your death.

Once you have gotten this far, one remaining step needs to be taken. This is the preparation of a personal financial review. Use a three ring binder and include a list of all your assets and liabilities. Include the account numbers, names and phone numbers of contacts. Then prepare a list of important documents, such as wills, power of attorney, and insurance policies, noting where they are located. Be sure to include the bank and location of your safe deposit box. Add the names of all your financial advisors, including your attorney and CPA. Once this is complete give copies to your next-of-kin, attorney, CPA and trustees, if any. Your CPA will use this information to make tax-planning recommendations, which could have been missed without it.

Once you have tamed the paper tiger, keep it under control by making it a weekly habit to go through your paperwork. Pay your bills and file any documents that you need to retain in the appropriate files. Once a year, give your system an overhaul. Discard any unneeded documents and files and move the old tax returns to the dead storage area.

Remember clutter is the enemy. Discarding unneeded paperwork is key to maintaining an organized financial record keeping system under control.

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William E. Philbrick, CPA, MST, CVA, CFF is a Senior Vice President and Director of Taxes and Forensic Services with Greenberg Rosenblatt Kull &Bitsoli, P.C. of Worcester, Mass. He can be reached at wphilbrick@GRK&B.com.

Is It “Good” For You? – Business Valuation is the Key

Worcester Jewish Chronicle, February 12, 2004

Is It “Good” For You? – Business Valuation is the Key

David J. Mayotte, CPA, CVA

There will be more wealth transferred in the next 10 years than in any other time in history:  The baby boomers will be retiring.  With their retirement comes the disposition and transfer of their businesses.

 Successful planning (along with a minimum of tax) is dependent upon the succession plans drawn up and, more importantly, having these plans put into action and followed.

 According to a recent study, conducted by the MassMutual Financial Group, of the 1,143 companies that responded to the MassMutual Financial Group/Raymond Institute American Family Business Survey, more than two-thirds (67.5 percent) reported a “good” understanding of the amount of estate tax that will be due upon their deaths.

 So, this sounds good, right?  This does, but their expectations might be unrealistic.

 Approximately 55.3 percent of the respondents to this survey indicated that they do not conduct formal business valuations of the company share value.  Without this information, they cannot accurately calculate their estate tax bill.  So, how can 67.5 percent of the respondents answer that they have a “good” understanding?

 It appears that a “good” understanding may be “bad” news for many business owners.

 So, what does this all mean?  Simply put, there should be a documented succession plan that is established based on current facts and circumstances using realistic sustainable values.  The succession plan should to be revised to reflect the current wants, needs and desires of the business owners as circumstances change.

 How much is your business worth?

Have you ever had a formal business valuation performed?  Why not?

If selling a business (known as a divestiture), a business valuator would help establish the value of the entity as a whole.  The business valuator would look at similar companies in similar industries to help establish the value of the business.  The business valuator would also examine the industry in which the entity operates; is the industry going through consolidation or rapid expansion?  The business valuator would also examine the national, regional and local economies as it relates to the entity being valued.  Today, more than ever, companies are dealing with customers all over the world.

 If gifting a business (to family members, for instance), a business valuation may be needed and attached to the gift tax return.  Documentation, such as a business valuation, needs to be included with the gift tax return if minority interest and/or lack of marketability discounts are taken against the value of the interest gifted.  Of course, without proper documentation, the IRS could successfully argue that the statue of limitations (generally three years for gift tax returns) never started because adequate documentation was not given.  Do not let that happen to you.

 A minority interest is usually defined as an interest that is less than 50 percent.  Lack of marketability tries to compensate for the illiquidity of the entity’s common and preferred stock.  The vast majority of all businesses out there are closely held, non-publicly traded.  The stock of these entities cannot be exchanged or sold on a timely or efficient manner.

 Maybe, instead of selling a business, one is buying a business (known as an acquisition).  Wouldn’t it be nice to see what an independent third party thinks of the company that you are buying?  And, more importantly, the price that you are paying?  A business valuator would examine the company’s strengths and weaknesses and determine the fair market value of the company.

 This leads to a very important phrase:  “fair market value.”

The IRS and the courts have defined this as follows:

“The price, expressed in terms of cash equivalents, at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arms length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.”

 Even when succession plans come together, circumstances beyond your control may go awry.  The best succession plans and implementation could be affected unexpectedly by litigation.

Many times, business valuations are required for litigation support such as shareholder disputes and divorce.  State law governs disputed property settlements.  In fact, most states have yet to establish standards of value.  Fair market value is usually not used in such cases.

Instead, fair value is usually the required premise of value.  The definition of fair value is as follows:

 “The value of the shares immediately before the effectuation of the corporate action to which the dissenter objects, excluding any appreciation or depreciation in anticipation of the corporate action unless exclusion would be inequitable.”

 This is a far cry from fair market value and can be more subjective.

In divorce proceedings, the business valuation is performed under the guidelines of the state in which the couple is getting divorced.  In most states, discounts for minority interests and lack of marketability are not allowed.  The court usually determines the date of the business valuation.

 As one can see, business valuations are important to today’s business owners as a key part of their succession plans.  Business owners should seriously consider if they should obtain an independent opinion of value on their business.

 Most importantly, succession plans should reflect the current wants, needs and desires of the business owners.

________________________________________________________________________

David J. Mayotte, CPA, CVA is a manager with Greenberg, Rosenblatt, Kull & Bitsoli, P.C., located at 306 Main St., and specializes in business valuations and closely held businesses.  He can be reached at 508-791-0901.

Rethinking Investment Choices Under the New Tax Act

The Advocate and Greenwich Time, Sunday, June 15, 2003

Rethinking Investment Choices Under the New Tax Act

Julie Jason

You are probably wondering whether you need to change your investment decisions because of new reduced taxes on corporate dividend distributions.

As we discussed last week, the Jobs and Growth Tax Relief Reconciliation Act of 2003, which was signed into law May 28, lowers taxes on corporate dividends received in 2003 through 2008. The act also lowers long-term capital gains to a maximum of 15 percent (5 percent for taxpayers in lower tax brackets) for stock sales after May 5.

Here is a ranking of income-producing investments based strictly on the effect of taxes, prepared with the help of tax experts Evan Snapper of Ernst & Young and William Philbrick of Greenberg, Rosenblatt, Kull & Bitsoli PC of Worcester, Mass.

The list is in the order of best tax efficiency to worst. The ranking will not tell you which investments you should buy, since that decision is not based solely on taxes. As the saying goes, "Don’t let the tail wag the dog."

As you are considering the list, think about whether you should hold some of your less-tax-efficient investments (ranking 4 or below) in a tax-deferred account, such as an individual retirement account, instead of a taxable account.

1.Tax-free municipal bonds: When the new tax act was proposed, income taxes on corporate dividends were to be completely eliminated, which would have made dividend-paying stocks not only the most tax-efficient, but also potentially more desirable to investors than municipal bonds. Since Congress reduced, but did not eliminate income taxes on dividends, municipal bonds remain the most tax-efficient income-producing investment.
2. Income-producing investments held in Roth Individual Retirement Account: You can withdraw dividends and interest (and principal and gains) from a Roth IRA completely free of federal and state income taxes, assuming you are over 59½ and have held your Roth for more than five years.

Because you can invest stocks and bonds in a Roth IRA, you might rank a Roth as the best all-round investment vehicle for flexibility and tax efficiency. It is ranked second here only because of tax penalties for early withdrawal (before age 59½) and the five-year holding period. 
3. Dividend-paying stocks: Dividends paid by domestic stocks or stock mutual funds investing in domestic stocks are now taxed at a rate of 5 percent or 15 percent, depending on your tax bracket.

4. Government bonds and government bond mutual funds and unit trusts: Interest from U.S. government and agency bonds, notes and bills is taxed at ordinary income tax rates. 

Government bond interest is exempt from state income taxes. Dividends paid by bond mutual funds are taxed at ordinary income-tax rates.

If your ordinary income-tax rate is higher than 15 percent (or 5 percent), then the top three choices on this list will be more tax-efficient for you than the rest. 

Who falls into that category? If you are single and you make more than $28,400, married filing jointly making more than $56,800, or filing as a head of household and making more than $38,500, your ordinary income tax rate will be higher than 15 percent – as high as 35 percent for the top bracket. 

5. All the instruments whose distributions are taxed at ordinary income tax rates on both the federal and state tax levels: These are savings accounts, bank certificates of deposit, corporate bonds and corporate bond mutual funds and unit trusts, immediate and tax-deferred annuities, and tax-deferred accounts such as traditional IRAs, 401(k)s and the like.

Note that some annuity and traditional IRA distributions or withdrawals may not be fully taxable. For example, there is an adjustment for nondeductible IRA contributions or a return of principal used to purchase a nonqualified annuity.

Capital Gains Taxes

In addition to taxes on distributions such as interest and dividends, you also have to consider whether there is a tax on the sales of the asset.

If you sell a stock or a municipal, government, or corporate bond at a profit, the gain will be taxed at the new long-term capital gains tax rate of 5 percent or 15 percent. 

To qualify for the lower rate, you must have owned the instrument for more than one year and the sale must occur after May 5. You may offset losses against gains as before, and losses can be carried forward. The $3,000 annual limit for deducting losses against income has not changed. 

If you withdraw money from a savings account, certificate of deposit, an annuity or tax-deferred account such as a traditional IRA or 401(k), profits or gains are not distinguished from other withdrawals and are taxed at ordinary income-tax rates.

However, withdrawals from annuities may include a return of principal, which would not be taxed. Traditional IRAs may also have been funded with nondeductible monies, which will reduce the amount that is subject to tax.

Watch out for penalties when you take out money from certificates of deposits and annuities. 

Be sure to talk to your tax adviser before making any decisions to realign your investments based on the new tax law.

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Julie Jason encourages readers to send in their 401(k) questions and stories for discussion in the column. Email Julie Jason atJulie.Jason@snet.net or write: Julie Jason, The Advocate and Greenwich Time, PO Box 9307, Stamford, CT 06904. Jason, a money manager who has a juris doctor and master of laws degrees, is the author of "Strategic Investing After 50" (John Wiley & Sons, 2001), "You and Your 401(k): How to Manage Your 401(k) for Maximum Returns" (Simon & Schuster, 1996) and "The 401(k) Plan Handbook" (Prentice Hall, 1997). She is managing director of Jackson, Grant Investment Advisers, Inc. of Stamford.

 

Recap of the Jobs and Growth Tax Relief Reconciliation Act of 2003

Recap of the Jobs and Growth Tax Relief Reconciliation Act of 2003

William E. Philbrick, CPA, MST, CVA

You are probably wondering how the new tax law will affect you. Read on to find out how the Jobs and Growth Tax Relief Reconciliation Act of 2003 will:

  • Reduce taxes on dividends and capital gains

  • Accelerate reductions in tax rates

  • Accelerate other tax benefits

  • Provide temporary tax relief for businesses

Reduced taxes on dividends and capital gains.

An important component of the new tax law, particularly for investors, is a reduction in taxes on dividends and capital gains. These temporary lower rates can mean considerable tax savings for taxpayers, although they will cease to apply after 2008.

Under the new law, the 10% and 20% rates on adjusted net capital gain are reduced to 5% (zero, in 2008) and 15% respectively, for both regular tax and the alternative minimum tax (AMT). The change applies to sales and exchanges (and installment payments) received after May 5, 2003 and before January 1, 2009. The 5% rate applies to taxpayers whose regular tax bracket is below 25%, while the 15% rate applies to those in tax brackets of 25% or higher. The lower rates apply to sales of capital assets held for more than one year.

Note, however, that there is no cut in the 28% capital gains rate affecting collectibles and certain small business stock, and the 25% rate for gains from depreciation claimed on realty.

Dividends received in tax years beginning after 2002 and before 2009 by an individual shareholder from domestic corporations and certain qualified foreign corporations are taxed at rates of 5% (zero, in 2008) and 15% for both regular tax and AMT purposes. This results in substantial tax savings for dividend recipients; before passage of the new tax law, dividends were taxed as ordinary income at rates of up to 38.6%.

Acceleration of certain previously enacted tax benefits and reductions for individuals.

The new tax law also speeds up previously enacted tax benefits and reductions that were scheduled to be phased-in over the next several years. These accelerated provisions include:

Expansion of the 10% individual income tax rate bracket. The expansion in the width of the 10% rate bracket for single and joint filers that was scheduled to take place in 2008 instead takes place this year. As a result, the 10% tax bracket for 2003 ends at $14,000 (up from $12,000) of taxable income for joint filers and $7,000 (up from $6,000) for single filers and marrieds filing separately. For 2004, both figures will be indexed for inflation. The endpoint of the 10% bracket for heads of household remains unchanged at $12,000. From 2005 through 2007, the endpoint of the 10% bracket will revert to the $12,000/$6,000 levels, but will increase to $14,000/$7,000 for 2008 through 2010.

Reduction in individual income tax rates. The change that will affect the largest number of taxpayers is an immediate reduction of the marginal tax brackets paid by all but the lowest earners. The tax rates above 15% for 2003 and later years are 25%, 28%, 33% and 35%, a decrease from previous rates of 27%, 30%, 35% and 38.6%. Previously, these rate reductions were scheduled to take effect in 2006. After 2010, rates above 15% will revert to 28%, 31%, 36% and 39.6%.

Marriage-penalty relief. The new law reduces so-called marriage penalties (i.e., tax-law provisions that force two-income couples to pay more in taxes each year than single individuals). The basic standard deduction amount for joint returns will be $9,500 for 2003 – double the basic standard deduction for single returns. Under prior law, this was not scheduled to be fully phased-in until 2009. However, beginning in 2005, a joint-return filer’s basic standard deduction will revert to the prior levels (e.g., for 2005, to 174% of a single return filer’s basic standard deduction).

In addition, in 2003 and 2004 the endpoint of the 15% tax bracket for joint returns will be twice the endpoint of the 15% tax bracket for single returns. Under prior law, this was not scheduled to happen until 2008.

In other words, for 2003, the 15% tax bracket for joint filers applies to taxable income over $14,000 (up from $12,000), but not over $56,800 (up from $47,450). However, for tax years beginning after 2004, the endpoint will, like the basic standard deduction amount, revert to previous levels.

Increase in child tax credit. For 2003, 2004 and 2005, the child tax credit will increase to $1,000 per qualifying dependent child under 17, up from the $600 per qualifying child for 2003 and 2004, and $700 for 2005 as previously provided. After 2005, the child tax credit will fall back to $700 for 2006 through 2008. What’s more, for 2003, the increased amount of the child tax credit will be paid in advance over a period of three weeks, beginning in mid-July. As a result, a typical qualifying family will receive an advance payment check for up to $400 for each qualifying child under age 17 as of the end of 2003.

Note that the income limits related to the child tax credit are unchanged by the Act, which means that the amount of the credit allowable is reduced or eliminated for taxpayers with adjusted gross income (AGI) over certain levels: $75,000 for singles and $110,000 for married couples. However, taxpayers who did not qualify in the past for the child tax credit because of AGI limitations may now qualify for a portion because of the increased credit, even though they will not get an advance payment.

Minimum tax relief to individuals. The tax law also includes some relief from the alternative minimum tax (AMT). For 2003 and 2004, the maximum AMT exemption for joint filers and surviving spouses increases to $58,000 (up from $49,000) and to $40,250 for unmarried taxpayers (up from $35,750), reverting to $45,000 and $33,750 respectively, in 2005.

Tax changes for businesses and corporations.

Two new temporary tax breaks are designed to encourage immediate investments. First, small companies can expense up to $100,000 in new equipment investments through 2005. Second, businesses can depreciate more of their assets sooner through 2004.

The 2003 Jobs and Growth Act vastly liberalizes the expensing election, which permits small businesses to expense (i.e., deduct immediately rather than depreciate over several years) a certain amount of the cost of tangible depreciable personal property purchased and placed in service during the tax year in an active trade or business. All of the following expensing changes are effective for tax years beginning after 2002 and before 2006:

  • The maximum annual expensing amount is $100,000, up from $25,000.

  • The maximum annual expensing amount is reduced (but not below zero) by the amount by which the cost of qualifying property placed in service during the tax year exceeds $400,000 (up from $200,000).

  • The maximum annual expensing amount will be indexed for inflation for tax years beginning after 2003.

  • Off-the-shelf computer software is now eligible for expensing.

  • Taxpayer revocation of expensing elections will no longer require IRS consent.

  • Certain SUVs and autos may qualify for 100% expensing if they meet weight and size requirements.

A second major change affecting businesses is an increase and extension of bonus first-year depreciation. In general, before the 2003 Jobs and Growth Act, a 30% additional first-year depreciation allowance applied to the non-expensed portion of qualified property if: (1) its original use commenced with the taxpayer after September 10, 2001; (2) the asset was acquired by the taxpayer after September 10, 2001 and before September 11, 2004; and (3) it was placed in service by the taxpayer before 2005 (before 2006 for certain property with longer production periods).

The Act makes the following changes:

  • For 30% bonus first-year depreciation purposes, property can be acquired before 2005.

  • 50% bonus first-year depreciation applies to qualified property if (1) its original use commences with the taxpayer after May 5, 2003; (2) the asset is acquired by the taxpayer after May 5, 2003 and before 2005 (there can not be a written binding contract for acquisition in effect before May 6, 2003); and (3) it is placed in service by the taxpayer before 2005 (before 2006 for certain property with longer production periods).

  • Taxpayers can elect on a class-by-class basis to claim 30% instead of 50% bonus first-year depreciation for qualifying property, or elect not to claim bonus first-year depreciation at all. Two situations in which a taxpayer would likely consider making an election to claim a smaller first-year depreciation, or to elect out of it entirely, are when the taxpayer (1) has net operating losses that are about to expire, or (2) anticipates being in a higher tax bracket in future years.

  • Note that there still is no AMT depreciation adjustment for the entire recovery period of qualified property recovered under the bonus first-year depreciation rules.

We’ve described only the highlights of the most important changes in the new law. There are new transition rules and specific definitions, coupled with the various sunset dates, all of which make planning more complex. In addition, we do not expect states to adopt any of the provisions of the new law.

Please be aware that there are several pending tax bills which can and will have a material impact on planning and compliance. It is expected that action will be taken on one or more of these bills in the coming sessions.

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William E. Philbrick, CPA, MST, CVA is a Senior Vice President and Tax Director at Greenberg Rosenblatt Kull &Bitsoli, P.C. of Worcester, Mass. He can be reached atwphilbrick@GRK&B.com.