If you are like me and process your proformas in January, you could have errors in the calculation of the federal minimum tax credit.

On Prosystem Form P-5, Box 80, the system carried forward the alternative minimum tax (AMT) attributable to 2006 deferral items, but it should have been the AMT attributable to 2007 deferral items. CCH Prosystem has corrected this error in later releases of the software, so if you generate the proforma at the time you prepare the income tax return or reprocess the proforma, it will be correct. It’s also simple to just correct the entry on the form.

In the heat of tax season, we sent several tax returns that had to be corrected – fortunately before April 18.

Be alert for this issue for your clients who are subject to AMT.

Good luck in the final 12 days of tax season!

Remember you can find past episodes at www.financialinsiderweekly.com under “past episodes”.

Remember you can find past episodes of Financial Insider Weekly at www.financialinsiderweekly.com.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the maximum federal gift tax rate for 2010 is 35%. If Congress does nothing, the maximum rate will return with a vengence to 55% in 2011, plus an additional 5% surtax for taxable transfers over $10 million until the benefits of lower brackets are phased out.

The gift tax applies for cumulative taxable gifts exceeding a $1 million lifetime exemption. Annual gifts of present interests by a donor to a donee up to $13,000 per year (for 2010) are also exempt from gift tax.

Also remember the federal generation-skipping tax is repealed for one year for 2010, creating the possibility of making significant gifts to grandchildren or generation-skipping trusts.

When the reduced gift tax is combined with leveraging strategies like making gifts of minority interests in family limited partnerships, long-term savings to the family can be significant.

Remember gifts of property aren’t eligible for fair market value basis adjustments that apply to inherited property, which will be reinstated after 2010.

It seems to me it’s highly likely the estate tax exclusion of $3.5 million will be restored after 2010, so making cumulative taxable gifts of more than $1 million to $3.5 million means losing the benefit of some of that exclusion. (Cumulative taxable gifts are added to the assets of the decedent less liabilities and other deductions when computing the federal estate tax.)

The wild card is whether Congress is going to attempt to reinstate these taxes retroactively for 2010. Proposals are all over the map, including doing nothing and giving taxpayers the choice of being taxed under reinstatement or under the rules enacted in 2001.

There are many considerations when making a significant gift, including eliminating your beneficiaries’ motivation to work. Some states also impose gift taxes.

You should consult with your estate planning advisors when planning any significant gift, and recognize there is a risk of exposure to retroactive imposition of a tax if you go ahead with a gift.

If we can be of service in helping you evaluate this decision, call Dawn Siemer for an appointment Mondays, Wednesdays or Fridays at 408-918-3162.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

S corporations that didn’t make the election from the time of beginning operations or that acquired another corporation that didn’t could have “accumulated (C corporation) earnings and profits”.

When an S corporation with accumulated earnings and profits has “excess passive investment income”, a special tax at the highest corporate tax rate applies to that income. (IRC Section 1375(a).) More importantly, if an S corporation has excess passive income for three consecutive years, its S election will be revoked. (IRC Section 1362(d)(3)(A).)

Passive investment income includes gross receipts from royalties, rents, dividends, interest, annuities and gains from sales or exchanges of stock or securities. There are exceptions relating to certain royalties and rental income that are beyond the scope of this article.

Passive investment income is “excessive” when it exceeds 25% of the S corporation’s gross receipts. This is especially a problem when a corporation is winding down or is holding real estate.

The exposure to the special tax and revocation of the Subchapter S election can be eliminated by distributing the accumulated earnings and profits of the corporation. A consequence of doing this is the distributions will be taxable as dividends income to the shareholders.

Under the Bush tax cuts, “qualified dividends” are taxed at a low 15% tax rate, like long term capital gains but not eligible for reduction by capital losses. After 2010, this tax break is scheduled to expire and dividends could be subject to the same tax rates as ordinary income.

The Obama administration has recommended extending the tax break for qualified dividends, but the maximum rate for qualified dividends for taxpayers with income over $250,000 would be increased to 20%.

Under the ordering rules for distributions for S corporations, income earned when the S election is effective, called the “accumulated adjustments account”, is distributed first and accumulated earnings and profits last.

A special election is available to treat distributions as first made from earnings and profits (IRC Section 1368(e)(3)(A).).

If the corporation made an S election before 1983, the corporation should also elect to forgo distributing and “previously taxed (S corporation) income” accumulated during the period the S election was effective before 1983. (Treasury Regulations Section 1.1368-1(f)(4).)

In addition, if the corporation doesn’t have cash available to distribute, an election can be made to have a “deemed distribution” taxed to the shareholders which is “deemed” to be reinvested in the corporation and added to the shareholders’ tax basis for their stock. (Treasury Regulations Section 1.1368-1(f)(3).) An S corporation that makes this election is also deemed to have elected to distribution accumulated earnings and profits first.

Since 2010 may be the last chance to get this tax benefit “on sale” at reduced tax rates, owners of S corporation stock should be discussing these elections with their tax advisors now, before they miss out!

IRS Circular 230 Disclosure:
As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.

(For this discussion, a “Roth” account is a Roth IRA account and an “IRA” account is a regular IRA or individual retirement account. An “employer plan” is a qualified retirement plan relating to your employment, including 401(k), profit sharing, 403(b) for nonprofit, 457 for government, and other less common plans.)

The advisor may then ask, “Do you have a 401(k) or other retirement plan at work?”

“Yes, I have a 401(k) account with about $100,000 in it.”

It may be that the $100,000 401(k) balance can be transferred to a Roth or IRA account. (Of course the transfer to a Roth would be taxable. See “Should You Make A Roth Conversion in 2010?” http://www.taxtrimmers.com/rothconversion.shtml)

Pension portability has been tremendously increased by the Economic Growth and Tax Relief Act of 2001 and the Pension Protection Act of 2006. With a few limitations, funds can be transferred from employer retirement accounts to a Roth or IRA account and, in some case, from a Roth or IRA account to an employer retirement account. The old “lump sum distribution” rules for rollovers are gone. Even partial rollovers are permitted and you don’t have to be more than age 59 1/2 to qualify if the distribution is made as a direct “trustee to trustee” transfer.

The employer account must permit such a transfer, so that can be an issue. Perhaps the employer can be persuaded to amend the plan to permit such transfers.

The only way to transfer non-deductible employee contributions from an employer plan to a Roth or IRA is through a direct “trustee to trustee” transfer.

Required minimum distributions and hardship distributions can’t be rolled over from an employer plan to a Roth or IRA.

The advantage of having the funds in a Roth or IRA account is to have the ability to make alternative investments for more diversification, such as investing in pre-IPO stock, real estate, and private money mortgages. (See “Permitted Investments For Roths and IRAs”. http://michaelgraycpa.com/2010/02/27/permitted-investments-for-roths-and-iras/)

The disadvantage of having the funds in a Roth or IRA account is the assets have less bankruptcy protection. Employer plans have superior asset protection. Consult with a lawyer about this before going ahead with a transfer from an employer retirement account to a Roth or IRA. It may be you should be transferring assets to the employer plan instead of the Roth or IRA!

What about inherited employer accounts? After 2009, beneficiaries must be permitted to rollover the balance to a beneficiary Roth or IRA account. The IRS surprised tax advisors by permitting a direct transfer of an inherited employer retirement account to a Roth account in Notice 2008-30, because inherited IRA accounts can’t be converted to Roth accounts. (Internal Revenue Code Section 408(d)(3)(C).) (Again, such a transfer would be subject to income tax.)

So, open your mind. You may have more investment flexibility with your retirement funds than you thought.

We can help you explore your alternatives. To make an appointment for an initial consultation, call Dawn Siemer at 408-918-3162 on Mondays, Wednesdays and Fridays from 9 am to 5:30 p.m. Pacific Time.

IRS Circular 230 Disclosure:
As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this communication was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.