Tax strategies, including party deductions, child payment, executor's rights, and IRS rule changes.
. . . plus paying your kids, helping your executor, and deciding when to petition the tax court
PARTY DEDUCTIONS If you use your home to entertain customers, clients, or business associates, it's a good idea to keep up with the changing rules for business-entertainment deductions.
As is true with other business meals and entertainment, you can deduct 80% of the actual cost -- provided the home entertainment satisfies one of two requirements. It must either be "directly related" to (business is discussed during the entertaining) or "associated with" (the entertainment directly precedes or follows a substantial and bona fide business discussion) the active conduct of business. When you're host to a business guest from out of town, the IRS allows you to deduct entertaining that takes place the day before or after the business discussion.
The law prohibits a deduction for "lavish or extravagant" entertainment, but hosting a first-class bash is not necessarily lavish or extravagant. If you include nonbusiness guests, however, you cannot deduct their share of the expenses.
Some home entertaining is 100% deductible. You are not subject to the 80% ceiling when, for example, you use your home to host a social gathering for employees -- a barbecue on July 4th or a Christmas party, for example. And you can take the deduction even if business isn't discussed. Note, though, that the party must be open to your employees generally, including the rank and file as well as top managers. -- Julian Block
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PROFIT FROM PAYING YOUR KIDS Buried in the fine print of the tax code are some valuable breaks for business owners who employ their children. To begin with, the wages are deductible by your company. And by putting your children on the payroll, you can keep income in the family, but shift some of it out of your higher tax bracket and into their lower bracket.
While a child under age 14 is now taxed at the parents' top rate for investment income above $1,000, the same is not true of wages. They are taxed at the child's rate. Consequently, it now may make more sense to pay wages to a child under 14 than to bestow properties generating an identical income.
Children age 14 and older are not taxed at the parents' rate on investment income, but wages may still be a better bet because of the standard deduction. The overhauled laws allow a child to use the standard deduction as an offset against income. Although the deduction offsets investment income by no more than $500, it's $3,000 for wages in 1988, a figure that is scheduled to go up in the future.
A word of caution: for this income-shifting device to survive an IRS audit, you must be able to establish that your children actually render services. Moreover, the wages that you pay them must be "reasonable," that is, not more than the going rate for unrelated employees who perform comparable tasks. -- Julian Block
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EXECUTOR'S RIGHTS There's a special provision of the tax code that you should pass on to the executor of your estate. It could well save him or her a hassle with the IRS.
As you probably know, the IRS has three years after a tax return is filed to raise questions. After that, the statute of limitations takes effect. But what sometimes happens with estates is that the estate is closed, the court discharges the executor from any further personal responsibility, and then the IRS turns up some irregularity from a year or two earlier. Because the IRS notice is within the three-year period, the executor is personally responsible even if the estate is closed. The mere fact that the executor had been discharged does not shorten the limitations period. A way around this difficulty is for the executor to request that the IRS issue a prompt assessment -- in effect, shortening the period of limitations -- or the statute of limitations will apply. -- Jay Brandzel
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RULE CHANGES When the IRS thinks you've underpaid your taxes, it'll send you a letter advising you of your rights to an administrative appeal. If you ignore that, or can't come to a settlement within 30 days, you'll receive by certified or registered mail a notice of deficiency. That gives you 90 days to file a petition stating your case with the tax court. The 1986 tax legislation for the first time gives taxpayers the right to request that the 90-day letter be canceled, and a recently issued procedure explains how to go about it. The question is, when should you take advantage of the new rule and when not?
Go ahead and fill out Form 8626 to cancel the deficiency notice if the dollars at stake are not large enough to justify the additional expense of a trip to tax court or if you think you can negotiate a settlement. The one problem is that the new procedure does not extend the 90-day limit, so if your request takes a long time to be processed and is ultimately refused, you may not have enough time to adequately prepare your petition.
If there are quite a few dollars involved, however, we suggest you file in tax court. In the ordinary course of events, the court will route your case back through the appellate division of the IRS, where you will have an opportunity to negotiate. You will have lost nothing except your legal and filing fees, and litigation is your ultimate protection. -- Jay Brandzel
Julian Block is a tax attorney in Larchmont, N.Y. Jay Brandzel, CPA, is national tax partner of Laventhol & Horwath, and is based in Philadelphia.
ESTIMATE OF UNPAIDFEDERAL INCOME TAXES, 1987
Amount Percent Source ($ millions) of total Individual income tax $63,475 74.8%
assets under $10 million
Unreported income 2,519
Overstated deductions 2,706
assets of $10 million
or more 15,845 18.7
Other 329 0.4
Total 84,874 100
Source: Internal Revenue Service Research Publication 7285, March 1988 n