Tax strategies including stock dividends, working lunches, mileage allowance, IRS rewards, and gift-tax traps.
. . . plus advice on gifts to children, lunch deductions, travel expenses, and telling the truth
Preferred Stock Dividends Declaring preferred stock dividends allows you to take aftertax dollars out of your corporation and transfer them to low tax-bracket family members, usually children, grandchildren, or retired parents. The stock dividends are tax free if declared proportionately to shareholders, and are a safe, practical, and inexpensive way to cut the family tax bill. (S corporations are not eligible.)
Let's assume you have four children and would like to use corporate funds to pay for their college educations. Declare a preferred stock dividend, and then give each of the children equal portions as a gift. Say the amount of your preferred stock is $40,000, resulting in $10,000 of stock as a gift to each child. Assume a 10% dividend rate, which yields $4,000 in total cash dividends or $1,000 per year for each child. If the children are older than 14 and have no other income, the cash dividends are tax free. For children under 14 years old, each child pays no tax on the first $500, and only $75 on the next $500; any unearned income in excess of $1,000 is taxed at your tax rate.
The tax consequences look like this:
Income tax Forty thousand dollars in value of the corporation (in preferred stock) is transferred to the family tax free.
Four thousand dollars of aftertax corporate income is taken out of the corporation in cash each year at little or no tax.
Gift tax No gift tax. (You can give up to $10,000 a year to each individual without gift-tax consequences. The amount is doubled if your spouse consents to the gift on a joint gift-tax return.)
Estate tax Forty thousand dollars is permanently removed from your estate.
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Deducting Your Working Lunches The cost of a working lunch among company executives during which important business is discussed is not necessarily eligible for the 80% tax deduction. It depends on the frequency.
Daily lunches, for example, are out. In a case brought to court a few years ago, the court said that personal activities such as lunch should not be awarded a tax windfall. To do so, it reasoned, would then entitle a commuter to a deduction for the cost of his commute because he happens to discuss business with a fellow worker during the trip. Though the lunch and the commute may be related to business, they are really a matter of personal choice. The court did suggest that monthly meetings would be deductible.
As a rule of thumb, then, an occasional business meeting at lunch or dinner with one or more co-workers is deductible, but daily meals are not.
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Mileage Allowance If you're tired of keeping records of the actual expenses you pay for the business use of your car, you can use the IRS optional mileage allowance instead and keep track only of your business miles. The allowance is 22.5 per mile for the first 15,000 miles, and 11 above that. You can also deduct 100% of business tolls and parking. The allowance isn't overly generous, but if you haven't the time to keep track of receipts, it is an alternative.
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How to Avoid the Gift-Tax Trap Most gifts of cash, bonds, or stock in a closely held corporation are made to children to get the value of the gift out of the parent's estate -- a good idea, with estate-tax rates ranging from a low of 37% to a high of 55%.
You may be thinking about giving such a gift to your minor children under the Uniform Gifts to Minors Act (UGMA). This is easy to do and doesn't require the creation of a trust. The problem arises when you name yourself custodian. If you die before your child turns 18, the gift will be swept back into your estate and taxed.
Fortunately, the trap can be avoided. Make your spouse or another third party the custodian. Also, do not become the successor custodian if the original custodian dies or resigns. You and your spouse should not make simultaneous transfers to an UGMA account; such a transfer will be included in the estate of a parent who dies while the child is still a minor.
Honesty's Reward Did you know that the IRS rewards people who give information that leads to the prosecution of taxpayers violating the tax laws? And that it does not have to reveal the identity of an informant in a civil or criminal case? That's potent stuff for somebody who may have an ax to grind against either you or your company.
The maximum amount payable to an informant is $100,000; the minimum is $25. The amount is determined according to a percentage (from 0.5% to 10%) of what the IRS collects. And the better the information, the higher the percentage.
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Irving L. Blackman, specializing in closely held businesses at Chicago-based Blackman Kallick Bartelstein, certified public accountants, speaks and writes on tax issues. n