Year End Planning Tips for Business and Individuals

Mario Fazio, MRFL's Certified Tax Specialist, gives year-end planning tips for businesses and individuals. His client alert is set forth below:

Year-End Planning Ideas for Businesses and Individuals
This Client Alert sets forth a list of year-end planning ideas for both businesses and individuals. We present for your consideration both legal and tax items that may significantly improve your "bottom line." We recommend that you review each of the items to determine its applicability to your particular situation. If you would like to discuss any of these matters in further detail, please feel free to contact one of our attorneys.

Business Items

Company Year-End Records Review – An ounce of prevention is worth a pound of cure. Both corporations and limited liability companies are required to maintain certain legal documentation. Annual meetings, elections of directors, managers and officers and approval or ratification of significant actions are required for almost all companies, big or small. Failure to maintain these records, or to annually update them, may create the risk of personal liability for the owners for the business’ debts and may also invite tax problems. Year-end "housekeeping" also gives business owners a good opportunity to review Bank documents, licenses, leases, contracts, permits, insurance and similar documents to ensure annual compliance.
Intellectual Property. A company’s proprietary information may be one of its most valuable assets if it creates a competitive advantage. Intellectual property may include customer and vendor lists, pricing information, marketing strategies and research, processes and similar trade secrets. Determine if all intellectual property is protected or, if any trademarks, trade names, copyrights, etc. are required to be filed or renewed. Where protection of trade secrets is critical to the continued success of a business, the company should consider adopting a formal Trade Secrets Protection Plan as well as a Records Retention Policy.
Employees. If you have employees, you should consider using employment agreements to protect the company’s trade secrets. Generally these protections can be accomplished through proper confidentiality, non-competition and non-solicitation restrictions.

Employment Handbook. The risk of employment-related law suits can be greatly diminished by having a properly drafted Employment Handbook, which outlines company policies and procedures relating to employment without giving rise to an enforceable "contract."
Employment Law Compliance. Any business with employees is subject to numerous legal requirements, which may include OSHA, EEO, HIPAA, tax and other laws. An annual review of these compliance issues may avoid costly governmental audits in the future.

Incentive Compensation and Succession Planning. Developing and retaining key employees may be critical to the ongoing success of a business, including the period after an owner’s departure. To attract and retain key employees, incentive compensation is frequently used to align the interests of the owners and the key employees. Year-end bonuses, profits interest, stock options, "phantom equity," stock appreciation rights, or stock grants are examples of incentive compensation plans. Any incentive compensation plan should be customized to the particular business and the people involved, so that it properly motivates, but does not over-compensate, the key employees.

Buy-Sell Agreements. A business owner should plan for an untimely death or disability, or his or her retirement from the business. Having in place a comprehensive buy-sell agreement with one or more co-owners, or third parties, will make it more likely that ownership transitions will be successful. Existing buy-sell agreements should be reviewed annually for compliance issues, such as whether a valuation of the business is required or life insurance coverage requirements are being met, or if the terms of the existing agreement still meet the owners’ goals and expectations.

Company–Owned Life Insurance. Life insurance may provide an important cash cushion during the time the business is recovering from the death of an owner or key employee. It can also be used to fund the purchase of an owner’s interest in the business. In 2006, Congress added a notice, consent and reporting requirement for company-owned policies acquired after August 17, 2006. Failure to comply with these requirements will cause the life insurance proceeds in excess of the company’s premium cost to be taxable as ordinary income to the company. The company must report annually its compliance with these requirements on its federal tax return. Life insurance policies owned by individual shareholders to fund "cross-purchase" buyout arrangements are not subject to these requirements.

Favorable Expensing Rule for 2009 Capital Purchases. There is a favorable tax deduction for purchases of new equipment, machinery and other tangible personal property, which are used in a business prior to January 1, 2010. Up to $250,000 of the cost of such property may be deducted in 2009, subject to a phase-out limit if the total of such purchases exceeds $800,000 for 2009. At this time it is unclear whether Congress will extend this provision for 2010 purchases.

Favorable Depreciation Rule for 2009 Capital Purchases. In addition to the first-year expense as outlined above, 50% of the remaining cost of such purchases (new machinery, equipment and other tangible property) may be deducted if the purchase is made, and the business begins to use the property, prior to January 1, 2010. The result of these two tax favorable rules is that all or a substantial portion of the cost of such purchases may be written-off in 2009. At this time it is unclear whether Congress will extend this provision for 2010 purchases.

Leasehold Improvements. 50% of the cost of qualified leasehold improvements, whether made by the tenant or the landlord, is tax deductible in 2009. The remaining cost may be depreciated over 15 years using the straight-line method (instead of the usual 39.5 year rule). At this time it is unclear whether Congress will extend this provision for 2010 leasehold improvements.

DISC for Exporters of US-Made Goods. A DISC is a separate corporation that meets certain requirements and makes a DISC election with the IRS. Owners of businesses that export US-manufactured goods may find it beneficial to establish a DISC to shelter up to 50% (or more) of the net income otherwise earned by the business from the export sales. The sheltered income must be paid to the DISC and is exempt from federal income tax. However, the DISC income is taxable as a dividend to the owner when it is distributed to the owner. For 2009 and 2010,
qualified dividends are taxed at the favorable 15% rate (which is far lower than the top 35% rate that otherwise applies to such income in the absence of the DISC).

Qualified Retirement Plan Contributions. To defer income, business-owners and employees should maximize their qualified retirement plan contributions. A standard 401(k) plan typically allows employees to make annual contributions of up to $16,500 for 2009. For profit-sharing plans, the contribution amount limit is $49,000 for 2009. Certain qualified pension plans may permit substantially higher contributions for the benefit of the owner depending on a variety of factors, including the owner’s age. New or amended plans may be adopted for 2009 on or before December 31, 2009. Deductible contributions for 2009 are due on or before the due date of the business’s tax return (including extensions) for 2009.

2009 Net Operating Losses May Be Carried Back Five (5) Years. Most businesses may elect to carry-back a 2009 net operating loss ("NOL"), either three (3), four (4) or five (5) years, instead of the normal two (2) year carry-back period. This additional carry-back period may allow businesses to convert a 2009 NOL into tax refunds for taxes paid in profitable years back to 2004.

Five to Ten Year Deferral of Tax on Cancelled Debt. Businesses may defer taxable income that arises from the cancellation, satisfaction or retirement of debt at a discount during 2009 or 2010 even though they are solvent and continue to operate. The tax break allows a business to elect to defer the taxable income until the fifth (5th) year following the year in which the cancellation occurs, and then report the income ratably over five (5) years (20% each year). Insolvent businesses whose debt is cancelled may continue to use the so-called "insolvency exception" to completely exclude the cancelled of debt from taxable income.

Individual Items

Roth IRA 2010 Conversion. Starting in 2010, the adjusted gross income (AGI) limitation on individuals electing to roll-over qualified plan assets to Roth IRAs will be eliminated. Thus, in 2010 everyone can consider making Roth conversions of existing traditional IRAs or rolling-over distributions from qualified plans to a Roth IRA. Generally, in making a conversion to a Roth IRA, the roll-over amount will be subject to income tax. For Roth conversions made in 2010, a special rule allows the income to be spread between 2011 and 2012 (half of such income in each year). The important benefit of a Roth IRA is the tax-free growth of the assets and the future tax-free distributions to the owner of both principal and income.

Energy Efficient Improvements to Residence. A maximum $1,500 tax credit is available for individuals who make improvements to their principal residence in 2009 and 2010 that meet certain energy efficiency standards. The credit is equal to 30% of the sum of amounts paid or incurred during the tax year for (1) energy efficiency improvements to the building envelope (for example, windows, exterior doors, roof) and (2) expenditures for qualified energy property.
Suspended Losses for Members of LLCs. Depending on the level of involvement of a member in the business of an LLC, recent judicial decisions may permit that member’s losses that were reported as suspended under the passive activity rules (Section 469 of the Internal Revenue Code) to be recharacterized as non-passive under certain limited circumstances. If you have suspended passive losses from a business in which you had some involvement (other than solely as an investor), you may be eligible to use those losses by treating them as non-passive depending on your circumstances.

Estate Planning. At least every three years or so, every individual should review his or her estate planning documents, including the Revocable Trust, Will and health care documents (living will, appointment of health care agent and HIPAA release). Due to changing family circumstances and changing laws, proper updating to existing documents may be required. For those individuals who own, or who are considering purchasing, life insurance, the use of an irrevocable life insurance trust may be advisable to avoid estate (death) tax on the proceeds.
Annual Gift Planning. Whether making intra-family or charitable gifts, completing the gifts prior to year-end is critical for tax planning. For 2009, an individual may gift up to $13,000 in cash or property to each family member or other persons. For a married couple, this amount may be increased to $26,000 per person. Using a family limited partnership or family limited liability company to facilitate the gifts may increase the size of these gifts by up to 50%, through applicable valuation discounts. Over a two or three decade period, an annual gift program, if properly structured, may pass to the next generation millions of dollars of family wealth without the payment of estate or gift tax.

Life Insurance. We recommend having your life insurance policies reviewed to determine if the death benefit is secure and the life insurance company has maintained its credit rating. In some cases, in addition to relieving your concern, these reviews can result in shopping the policy for a lower premium payment for the same or greater death benefits. If you wish to review your current life insurance, you should contact your life insurance broker, or let us recommend some brokers with whom we have worked. Many brokers will perform the review for little or no charge.

Use of Estate Planning Trusts to Provide Asset Protection. Use of a lifetime irrevocable trust created by a person (grantor) for the benefit of the grantor’s spouse and/or other family members may be designed to provide asset protection for the trust assets against creditors of both the grantor and the family members. A wholly discretionary trust generally provides the maximum amount of asset protection. A wholly discretionary trust is one that is irrevocable, grants the trustee broad discretion to determine the timing and amount of distributions to beneficiaries, and meets other requirements.

Home Buyer Credit Extended and Liberalized. The so-called $8,000 "first time home buyer’s tax credit" has been extended to include purchases of principal residences on or before May 1, 2010. The tax credit also applies to the purchase of a principal residence before July 1, 2010 by any taxpayer who enters into a written binding contract before May 1, 2010 to close on the purchase on or before July 1, 2010. The tax credit is also now available to higher income taxpayers whose modified AGI does not exceed $225,000, with a complete phase-out at modified AGI of $245,000 for joint filers. In addition to first-time buyers, the tax credit is now available to "long-time residents," who are defined as maintaining the same principal residence for any five-year period during the eight-year period ending on the date of the purchase of the new residence. The new law also imposes an $800,000 purchase price limit.

IRS CIRCULAR 230 DISCLAIMER: To the extent that this Client Alert may address certain tax issues, this written communication is not intended or written to be used, and cannot be used, by any persons to avoid any potential tax penalties that may be asserted by the Internal Revenue Service. In addition, this communication may not be used by anyone in promoting, marketing or recommending the transactions or matters addressed herein.
This Client Alert is a summary only, prepared for general informational purposes, and is not an exhaustive description of the complex legal issues addressed herein. Nothing in this Client Alert is intended or is to constitute a legal opinion or legal advice from Meyers Roman Friedberg & Lewis or any of its attorneys. This Client Alert is not intended or written to be used, and cannot be used, by you or any other person to avoid any potential tax penalties that may be asserted by the Internal Revenue Service. To the extent the attached Client Alert mentions federal tax matters, it is not intended or written, and cannot be used, for the purpose of avoiding federal tax penalties. In addition, the attached Client Alert may not be used by anyone in promoting, marketing or recommending the transaction or matter addressed therein.