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Abusive Tax Shelter Back to Top

Tax saving machinations that the IRS views as excessive and for which additional penalties may be applied including potentially a penalty under Code Section 6700 which can be 100% of the gross income from the activity and which can be assessed against the promoter of the abusive tax shelter.

Abusive Tax Shelter Back to Top

Tax saving machinations that the IRS views as excessive and for which additional penalties may be applied including potentially a penalty under Code Section 6700 which can be 100% of the gross income from the activity and which can be assessed against the promoter of the abusive tax shelter.

Accelerate Expenses Back to Top

A common year-end tax planning step is to pay for certain expenses prior to December 31, rather than incur them after December 31. This can give you the tax benefit of a deduction a year earlier than if you had waited until January 1 or later to pay the expense. An example of this is to pay your estimated state taxes by December 31, rather than by the following January 15 when it is often due.

Accelerated Cost Recovery System Back to Top

The rules for calculating depreciation (annual write-offs) for buildings, furniture, and other assets were called the Accelerated Cost Recovery System (ACRS). The depreciation system after 1986 is called the Modified Accelerated Cost Recovery System (MACRS). Depreciation write-offs are technically called recovery deductions under these rules. The basic approach to calculating depreciation under these rules is to multiply a percentage provided in charts by the IRS by the costs (adjusted basis) of the building, furniture, or other assets you are depreciating. The depreciation period for certain commercial real estate, for example, is 39 years.

Accredited Investor Back to Top

An accredited investor is an investor who meets certain standards set by the securities laws to invest. If the only people investing in a particular investment are accredited investors a lower standard of reporting may be required of those organizing the investment. The standards to qualify as an accredited investor seek to identify investors with sufficient net worth and financial sophistication. For example, an individual who alone or with his or her spouse has a net worth in excess of $1 million is an accredited investor.

Accrual Method Back to Top

The tax laws provide sets of rules for determining when you can claim a deduction and when you must report income. There are two major sets of rules. The simplest, which is used by individuals, is called the cash method of accounting. Under the cash method of accounting, you generally report income for tax purposes when you receive it and generally deduct expenses for the year you pay it. Under the accrual method of accounting, which is used by many businesses, partnerships, corporations, and so forth, income is reported and expenses deducted in the year to which they relate rather than the year when paid.

Accumulated Earnings Tax Back to Top

A penalty tax charged against a corporation that retains an excessive amount of profits beyond the reasonable needs of its business, rather than distributing those profits to its owners. An LLC that is taxed as a partnership will not face this problem.

Acquired from the Decedent Back to Top

Property Must Be "Acquired From" the Decedent to Be Subject to the New Basis Adjustment Rules in 2010 under the optional 2010 carryover basis rules

The general rule noted in the preceding section applies to property "acquired from" the decedent. This term must be defined to understand when the new rules will apply. Property acquired by devise (real property received from a decedent), bequest (personal property received from a decedent), or inheritance or by the decedent’s estate from the decedent, will be deemed "acquired from" the decedent. Also included is any other property which passes from the decedent by reason of the decedent's death if passed without consideration (i.e., not paid for by the recipient). This includes property the decedent owned as a joint tenant with the right of survivorship or as a tenant by the entirety. For jointly held property between spouses the property is deemed 1/2 owned by each spouse. This means only 1/2 the value of jointly held property can be stepped up in value by application of basis adjustments or stepped down in value (if the fair market value at the date of death is less than the decedent’s basis, as described below regarding exceptions) if the carryover basis regime is elected.

Property transferred by the decedent to certain trusts, will similarly be subject to the carryover basis adjustment rules. Property transferred to a “qualified revocable trust” ("QRT”) will be subject to the new carry over basis rules. Finally any other trust with respect to which the decedent reserved a right to change the beneficial enjoyment of the trust property by exercising a right reserved to the decedent to alter, amend or revoke the trust, will be treated as property “acquired from” the decedent and subject to the new basis adjustment rules. This includes trusts included in the decedent’s estate under Code §§2036(a)(2) or 2038, but trusts included in the estate under Code §2036(a)(1) will not be treated as “acquired from the decedent” even if though the trust is in the decedent’s gross estate.

Acquisition Costs Back to Top

When buying a business or property, many costs can be incurred that have to be added to (capitalized as part of) your cost (adjusted basis) in the property. For example, the cost of a title insurance report, legal fees, transfer taxes, accounting fees, and so forth may all have to be added to your cost in the property. If the property is an investment property, and not your home, carefully evaluate the acquisition costs to find expenses that you can currently deduct. Plan how you allocate the total acquisition cost between land, building, furniture, and other assets you purchased, since land can't be written off (depreciated), and buildings and furniture can be written off (depreciated) quickest of all.

Active Income Back to Top

See Passive Loss Rules.

Active Participation Test Back to Top

Investors sufficiently involved with their rental property to meet this test, and have income (See Modified Adjusted Gross Income) less than $150,000 can deduct some or all of the tax losses, up to $25,000, from their rental property against any income including wages (active income) and dividends and interest (portfolio income). The amount of this $25,000 loss allowance that can be used is reduced as your income exceeds $100,000, and is eliminated entirely when income reaches $150,000. To meet the active participation test, you must own at least 10 percent of the investment, make management-type decisions (approve new tenants, set rental rates, approve major repairs), and so forth.

Adjusted Basis Back to Top

Roughly speaking, your investment (for tax purposes) in certain property (the cost you pay to buy or build a building [or any other asset], plus costs to improve it). If you have a casualty loss, it reduces your adjusted basis. Adjusted basis is used to calculate depreciation (multiply it by the appropriate depreciation or ACRS percentage) and to determine the taxable gain or loss when you sell property (subtract adjusted basis from your net sales proceeds to determine your gain). If you're subject to the alternative minimum tax, your assets may have different adjusted basis for the regular tax and the alternative minimum tax.

Adjusted Gross Income Back to Top

All your income from whatever source (wages, rents, dividends, profits from a business, and so forth) less certain deductions (trade or business expenses, depreciation on rental property, allowable losses from sales of property, alimony payments, and so forth). It is sometimes called AGI. Adjusted gross income is important for calculating the amount of medical expenses and casualty losses that you can deduct. The $25,000 special allowance to deduct rental expenses when you actively participate is based on modified adjusted gross income, which is adjusted gross income increased by any passive activity losses, certain social security payments, and individual retirement account deductions (IRAs). This is important in assessing the value to an investment in the now permanent low income housing credit.

Adopted Child Back to Top

If a child is adopted, does that adoption have the child included as an heir under a will or trust? The issue can raise a host of complexities and problems. Is a child that is born from frozen sperm or eggs considered an heir? What if the child was born after the death of the parent who donated the sperm or egg? If a person is subject of an adoption while an adult, how is that person treated under the terms of a will or trust? As society and family structures become more complex and variable, these issues will continue to grow in importance and there is likely to be considerable litigation in future years over these issues. When you are preparing a will or trust consider taking the time to carefully evaluate and address these concerns.

Adverse Party Back to Top

When determining how a trust will be treated for income tax purposes, the definition of "adverse party" is important. If certain prohibited powers are held by someone who is not an adverse party the trust will be treated as a grantor trust for income tax purposes. This means that the trust income will be taxed to the grantor. For purposes of the grantor trust provisions of the Internal Revenue Code, the term "nonadverse party" means any person who is not an adverse party. The term "adverse party" means any person having a substantial beneficial interest in the trust which would be adversely affected by the exercise or nonexercise of the power which he possesses respecting the trust. A person having a general power of appointment over the trust property shall be deemed to have a beneficial interest in the trust.

Agent Back to Top

An "agent" is someone who acts on behalf of or represents another person called the "principal". The principal appoints or designates another to act as his or her agent.

That designation can be accomplished in a number of different legal documents and for a myriad of purposes. The relationship can be created verbally, although there are limitations. The courts may even infer in certain circumstances that an agency relationship exists even when the parties involved did not formally create one (e.g., implied contract).

In some instances the relationship of principal and agent is referred to as "master" and "servant". An example would be an employer for whom an employee serves as an agent.

An agency relationship is a "fiduciary" relationship, a position of trust. This is important for an agent to consider as it affects the level and degree of responsibility that the agent has.

An agent can be appointed in a commercial context. For example, a wholesale distributor appoints someone as his agent in a particular geographic region to sell. An agent relationship is commonly created in a personal estate planning context by signing a power of attorney.

There are a host of different types of agencies. For example, you can designate someone as your "exclusive agent" so that they have the exclusive right to handle a particular transaction. You can designate a A"general agent" who has broad authority to transact business or other matters for you. You can create an "implied agency" by your actions that create the impression that a particular person is your agent.

Agreement of Sale Back to Top

An "agreement of sale", might also be called a "contract of sale", "purchase contract", "purchase and sale agreement", or by any number of similar terms. It is in general terms a legal document (contract) in which one person (party) called the buyer agrees to buy or purchase from another person, called the seller, specified items. The items being bought could be a house, in which case a "real estate contract of sale" or similar name might be used. It could be a contract to purchase a business, which might be a "stock purchase agreement" if the business is a corporation and the stock in the corporation is being purchased. In all cases the agreement should provide in clear detail who is selling what to whom and on what conditions. In most agreements of sale there are representations and warranties by each side of the transaction, often attached documents (called schedules or exhibits) providing further information (disclosures), specifications as to any conditions for the transaction to be concluded (called conditions to closing), etc. Be very careful using any boiler plate document. Any contract should be tailored to fit the specific issues in the deal you are doing.

Alimony Back to Top

Alimony is the payment of support or maintenance to an ex spouse, generally pursuant to a court order. Alimony may be tax deductible by the payor if it meets the requirements of Code Section 215. These requirements include that the payments must end on death of the recipient spouse (payee). The parties cannot agree or specify that the payments are not deductible. The payments must be made to your ex spouse from whom you are legally separated and who is not part of the same household as you. The recipient spouse must generally report the payments as income under Code Section 71.

Allocation Back to Top

The purchase price for a business or a rental property must be allocated between different assets acquired, such as intangible rights (customer lists, etc.), land, building, furniture and fixtures, equipment, inventory, etc., in order to determine your depreciation deductions. See Acquisition Costs.

Alternate Valuation Date Back to Top

When someone dies their assets are valued for estate tax purposes as of the date of their death. However, there is a special election which permits the executor or other fiduciary for the estate to value estate assets as of a date 6 months following death. This is called the "alternate valuation date" or sometimes the "alternate valuation method", or "AVM" for short. Using this election, the estate assets can generally be valued six months following death. If the value of assets has declined significantly post death, this can provide a tremendous estate tax savings. The AVM election, once made, is irrevocable. In order to make this election the value of the gross estate (everything the decedent owned) and the tax due, both must be lower at the alternate valuation date then at the date of death. The special rules governing this are contained in Code Section 2032.

Alternative Depreciation System Back to Top

Special rules must be used to calculate depreciation (recovery deductions) for real estate and other property if you're subject to the alternative minimum tax, the property is financed with tax exempt bonds, etc.

Alternative Minimum Tax Back to Top

This is a second parallel tax system that many wealthier taxpayers will have to consider when calculating their tax. The alternative minimum tax (AMT) is calculated by starting with your taxable income calculated according to the regular tax rules. Add certain tax preference items and adjustments required by the AMT. Only certain itemized deductions are allowed. Next, subtract an exemption amount. The result is multiplied by the amount rate for individuals. If the tax due exceeds the tax you owe under the regular tax system, you must pay the larger alternative minimum tax.

Amortization Back to Top

Deductions for writing off the cost of property (Internal Revenue Code Section 197 assets) over its useful life (the estimated number of years the property or asset will be useful in your business) is called amortization. Certain intangible assets acquired when purchasing a business now are amortized over a 14- year period.

Amount Realized Back to Top

The money and the fair market value of any property you receive when you sell property. It also includes the amount of any liabilities that the buyer takes responsibility for.

Annual Exclusion Back to Top

Every person is permitted to give away up to $10,000 per year to any other person without incurring any gift tax. There is no limit on the number of people you can make these gifts to in a year. To qualify for this exclusion, the gifts must be a gift of a present interest, meaning that the recipient can enjoy the gift immediately. This can present problems when you make gifts to trusts. This exclusion can be doubled to $20,000 per person, per year, if you're married and your spouse consents to join in making the gift. This is called gift splitting. These amounts are indexed for inflation.

Annual Meeting Back to Top

Corporations should have annual meetings for both directors and shareholders. Notice of the meetings should be given in advance as provided for in the by laws of the corporation or as provided under state law. At each meeting the Corporation should have a required minimum required number of directors or shareholders, respectively. This minimum is referred to as a "quorum". Minutes documenting the meeting should be prepared, signed and filed in the corporate kit. For many closely held businesses unanimous consents are often signed in lieu of having meetings.

Although it may not be legally required, many attorneys recommend meetings for members and managers of LLCs and even partners of partnerships.

Applicable Exclusion Amount Back to Top

This is the amount of property you can give away without triggering any estate tax. On the federal level in 2006 you can gift or bequeath a maximum of $2 million in assets without triggering tax (only $1 million while you are alive, but up to another million or $2 million at death). This amount is referred to as the "applicable exclusion" amount. Under prior law it was called the "unified credit". This amount increased to $5 million in 2010-2012. But the 2010 Tax Act made a number of other changes, some noted below.

This is generally the amount which a client can bequeath at death without triggering an estate tax (to the extent the client did use up exclusion by making taxable gifts during lifetime). This term from prior law has been redefined to encompass the new estate tax concept of portability (the surviving spouse’s being permitted under certain conditions) to use the remaining basic exclusion amount from his or her previously deceased spouse. (Your Basic Exclusion Amount + Portable Amount from your Last Deceased Spouse = New Applicable Exclusion Amount). So if your spouse died and you did not remarry, in 2011 and 2012 you could bequeath $10 million without tax. The $10 million in assets ($5 million if you cannot use a pre-deceased spouse’s exclusion) avoids estate tax on that amount of assets. The amount of tax avoided is the “Applicable Unified Credit” below.

Applicable Unified Credit Back to Top

The unified credit is the amount of estate tax credit that is available to your estate to eliminate the estate tax your estate would pay on the applicable exclusion amount, which includes the basic exclusion amount (i.e., $5 million, indexed, of taxable estate (loosely, assets) and the deceased spouse’s unused exclusion amount. The applicable credit amount is $1,730,800 on the basic exclusion amount and 35% (the marginal tax rate) multiplied by the amount of your deceased spouse’s unused exclusion.

Appreciated Property Back to Top

Any asset that has increased in value from the date that you first purchased or acquired it. If you sell the asset in most circumstances you will pay income tax (either capital gains tax or regular income tax) on the appreciation above your basis (what you paid for the asset). Charitable remainder trusts, like kind exchanges, and other techniques can sometimes be used to defer or avoid some portion or all of this gain.

Articles of Formation Back to Top

See "Articles of Organization". When forming a limited liability company "LLC" in a state you will generally begin the process by filing a certificate (legal form) with a designated office in the state. This form goes by various names in different states. Caution - while this can be done on line inexpensively in many instances, there are actually a host of nuances of what you need to consider when preparing such a certificate. Its often cheaper and safer in even the short run to have an attorney help you address this. Its not only the minimum essentials to get organized. You really need legal judgement to determine if your business form (LLC or otherwise) is correct for your situation, whether you need ancillary entities or documents (e.g., a separate LLC to own passive assets used in the business), etc. The tax status for the entity should be addressed (disregarded entity, partnership, S corporation, etc.).

Articles of Organization Back to Top

May also be called certificate of formation. This is the initial document filed with your state to form or organize your LLC. It includes basic provisions concerning the life, nature, owners, etc., of the LLC and becomes a matter of public record.

As Is Back to Top

When you sell something "AS IS" it means that the buyer is purchasing it in whatever condition it is in. This is in contrast to the seller making certain representations, or providing warranties, in other transactions. Thus, if you are buying something and the contract says its being sold "AS IS" you had best take to heart the phrase "buyer beware".

Asset Protection Back to Top

The process of taking steps to minimize the risk of creditors or other claimants from being able to reach your assets. This can include setting up a different entity, such as an LLC, for each property, business, etc. Thus, if one particular property is subject to a suit (e.g., a tenant is hurt on one rental property) the claimant will be limited to the assets from that particular property or entity. This can prevent a domino effect against your other assets. An LLC, just like a limited partnership, offers important benefits where asset protection is important.

Assignment Back to Top

An assignment can be a legal document used to transfer ownership or rights. For example, if you have a business that leased a property or piece of equipment, and set up a new business, you may wish to assign or transfer the right to use that equipment or property to your new business. Thus, you could, assign the lease to the property to your new company. Before completing any assignment, you should carefully review the contract (e.g., lease) involved to see what pre-conditions you have to meet to being able to make an assignment effective.

At-Risk Back to Top

The at-risk rules limit the amount of tax losses you can deduct from a business or investment to the amount you have at-risk in that investment. The amount at-risk includes the cash and the fair market value of any property you have invested in the business. The amount at-risk (your deduction limit) also includes debts for which you are personally liable (the bank can sue you personally to collect the debt).