This article was published in the "Martinelli Newspapers" in the March 23, 2006 weekly issue of The Westchester Crusader, The Rye Chronicle, The Eastchester Record, The Pelham Sun, The Sound View News Home News & Times, The Mt. Vernon Independent, Harrison Independent
and North Castle News

Life and Money TM- Tax Tips for Tough Times

By Frank Sisco, CPA, PFS

(Word count =  1,520 including 69 words for About the Author)

Nearly all of us go through tough times at one point.  Tough times can happen due to a death in the family, a disability, a failing business, a lost job, damage caused by nature, a major car accident, a ravaging illness, emotional conflicts, and the list goes on.  We all know that during such times, you should get the emotional support of relatives and friends and perhaps advisors, and have a positive attitude coupled with faith. It is also wise to minimize the financial damage that may also occur.  Cutting current and future taxes is one such step.  The saved money could come in handy to improve the situation at hand and perhaps help in the future.  Seek the advice of a CPA, or other trusted tax expert, who has specific experience with these situations because the tax laws can be complex and implementation can have significant ramifications. 

1. When tough times are brought on by losses of a failing or failed business.

When a business loses money, there are steps to take that could save taxes, both currently and in the future.   For an ongoing business that has losses, the owner should consider generating taxable income from other activities that could be matched against these losses, thereby eliminating the future taxes that would have been incurred on that taxable income.  For example, if your business lost $200,000 this year, you may consider selling a rental property that has an unrealized gain (perhaps even to a family member at its true present value) thereby eliminating the taxes on the gain that would ordinarily be incurred when you sell it. Also consider selling investment securities with significant appreciation to utilize the tax loss.  Another strategy would be to carryback the loss to prior years, by filing amended tax returns, and receive a refund of some or all of the past taxes that were paid.  For taxpayers who may be subject to estate taxes in the future and who own a business that now has a much lower value, the present may be an opportune time to shift some of the ownership to children or grandchildren because the gift amount may be much less, thereby using less of the gift/estate tax exclusion.

For a business that is sold or closed at a loss, you should obtain the advice on using Section 1244 of the Internal Revenue Code.  Steve Serwatka, CPA and partner of Arthur Allen and Company located in Greenwich, CT, said recently, in summary, that Section 1244 allows certain corporations (e.g. those with a capitalization under $1 million; pertaining to the original owners' investment) to treat such losses as "ordinary losses" rather than "capital losses."  Ordinary losses can reduce ordinary income (e.g. wages, interest, rental income) without limitation while capital losses cannot, except for $3,000. Mr. Serwatka also suggests that a taxpayer consider using certain provisions of the tax laws related to hobby losses in order to deduct certain expenses that the taxpayer might have ordinarily overlooked as deductible.

For losses related to businesses that are either continuing or are terminating, an effective tax strategy is to withdraw money from IRAs and other retirement accounts in order to generate taxable income to offset the losses.  This removes the future tax liability attached to those retirement funds, which can now be invested in liquid savings accounts. Frank LaRusso, CPA in Harrison, NY, indicated that he has applied this strategy in several client situations with beneficial results.   A similar technique is to withdraw money from tax-deferred annuities and also to convert traditional IRAs, which are taxed when withdrawn, into Roth IRAs, which are not.  Roth IRAs have the additional benefit of being exempt from the minimum distribution rules which start at age 70 ½.

2. Disaster losses.

Losses from disasters and casualties such as floods, hurricanes, thefts, accidents, etc. are deductible up to certain limits (e.g. 10% of adjusted gross income).  However, The Katrina Emergency Tax Relief Act of 2005 removes the restrictions, which can help people get back on their feet, by saving taxes.

3.  Medical expenses and long-term care costs.

Sadly, many seniors find themselves paying significant amounts of medical expenses, especially for long-term care, most of which is not covered by regular health plans or Medicare.  In years when these expenses exceed income, a person should consider generating taxable income to make some use of these losses, rather than incur the income in a year when there are not such expenses and the income would be taxed.  One way to generate income is to sell appreciated assets such as a house or investment securities, offsetting the gains against the expenses.  This may also provide needed funds for future expenses.  Another is to withdraw from tax-deferred accounts as discussed above.

Many seniors have long-term care insurance, for which certain amounts of premium are deductible as medical expenses.  Furthermore, expenses incurred at a nursing home or other long-term care facilities, generally, are more easily deductible due to recent tax legislation which expands the deductibility of an expense from being related to medical care to being related to long-term care, enabling many more expenses to qualify as deductible medical expenses.  For in-home care costs to qualify if they relate to long-term care services, the taxpayer must be chronically ill and the services must relate to a plan prescribed by a licensed health care practitioner, which is often the case.

In the past, some seniors would strip themselves of assets by transferring them to family members, such as children, wait a certain length of time, and then apply for Medicaid, so that Medicaid would pay the medical costs.  This strategy has been made much more difficult by the new tax legislation (Deficit Reduction Act of 2005) signed by President Bush on 2/8/2006.  The Act, among other things, extended the look-back period for transfers after 2/8/2006 to five years from three years, and starts the penalty period for the transferred assets at the time the applying person enters the nursing home, rather than starting the penalty period at the time of the transfer.  It is not yet clear how New York State will adhere with the Federal law, but anyone considering Medicaid planning should seek expert guidance.

There are certain tax benefits for a terminally ill individual.  If he or she receives an acceleration of death benefits from a life insurance policy, which is allowed by several insurance companies, the benefit can be tax-free, subject to certain conditions.  Also, if a person sells their life insurance policy in connection with a viatical settlement, the proceeds can be excluded in full from income for the terminally ill individual or excluded up to the amount of the unreimbursed qualified long-term care expenses in the case of a chronically ill individual.

For someone who suffers a disability or illness, it may be necessary to modify the home or install special equipment, and the costs are deductible medical expenses, as pointed out by Richard Kondub, CPA, in Harrison NY.   Examples are constructing an entrance or exit ramp, widening doorways or hallways, installing railings, grading the ground, installing a chair lift, adding handrails, etc. 

4.  Family relationship issues.

Financial distress can cause people to reconsider their planned allocations among relatives, and because of high amounts of gift exclusions (e.g. $1,000,000 lifetime) and estate tax exclusions ($2,000,000) a rough financial year might be just the time to consider making intra-family gifts. Also, disruptions within a family, such as divorce, can cause severe financial harm.  One of the prior tax act's provisions, that is effective in 2005, allows a divorced individual to use, from the other spouse, the S corporation losses that were suspended due to basis limitations.  In addition, depending on the tax situations of the spouses, it may be appropriate to use or not to use the tax benefits of (a) transferring property without tax among spouses or (b) characterizing certain property settlements as alimony.

5.  Declines in value.

Some people experience a sudden loss in the value of a property or an investment, and the loss may appear to be permanent.  Capital loss tax provisions can help reduce the tax burden, especially when such losses are used to offset capital gains from the sale of other assets.  When declines in value happen with a property or an investment, it is an opportunity to take gains in other assets, or to elect favorable tax-free exchange treatment into other like kind assets under IRC section 1031.

There will be further elaboration in future columns of tax tips and financial planning strategies that may be helpful to people who are going through tough times, as briefly discussed in this column, and also discussion of other topics including the financial aspects of dealing with the death of a family member.

About the author.

Frank Sisco is a CPA and Personal Financial Specialist, and author of many articles about personal finance and issues of life and money.   His firm, Financial Management Corporation, is located in Harrison, NY.  Frank makes his home with his wife and daughter in New Rochelle, NY.  He can be reached at 914.381.3737 or by email at ideasmoney@aol.com.  Visit his website at www.LifeAndMoney.com, which contains this and prior articles.