Last Minute Tax Planning Opportunities, Part 2 of 2.

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, December 26, 1999.

Copyright 1999 Robert L. Sommers, all rights reserved.

Part 2 of 2

Last Minute Tax Planning Opportunities, Part 2 of 2

Annual Gift-Tax Exclusion

Maximize your annual gift tax exclusion by gifting up to $10,000 (couples may gift $20,000), per beneficiary, in money, stocks or property, by year's end. Since this annual benefit expires on December 31 of each year, for those facing large estate taxes, it is prudent to maximize your gift-giving privilege each year. Note: Gift-giving reduces your estate for estate tax purposes, but does not reduce your income tax burden. There is no income-tax deduction for gifts.

Gifts Using a Minority Discount

Use the "minority discount" technique to gift a much larger percentage of property than the equivalent amount of cash. For example, a couple owns real estate worth $200,000 and gifts a 10% interest to their daughter. If the gift is subject to a 30% minority discount, the interest is not valued at $20,000 ($200,000 x 10% -- the pro-rata amount of the total value), but is worth only $14,000. Thus, a 14.25% interest initially worth $28,500 but then discounted by 30%, receives a value of $19,950, which is under the $20,000 annual gift tax limit.

By forming a family limited partnership (FLP) then gifting limited partnership interests at a discount, taxpayers hope to substantially reduce their estates. But be cautious about using a FLP to create minority discounts when the partnership merely holds appreciated securities or other passive investments. This no longer works (if it ever did) and IRS is aggressively challenging these arrangements as lacking economic substance.

Watch for California's Proposition 13 Reassessment

If you are using FLP techniques for real estate, make sure you structure the transaction so as not to create a "reappraisal" under California's Proposition 13. You need to transfer the gifted amount in real estate directly to your children, and than have the children and you transfer a total of 100% of your interests to the FLP. In subsequent years, you can use the annual gift-tax exclusion to gift portions of your FLP interest to your children without causing an immediate Proposition 13 reassessment.

Note: A reassessment will occur when the "original owners" collectively transfer (in one or more transfers) more than 50% of his or her interest or when another FLP member obtains more than a 50% interest.

Keoghs and IRAs

Self-employed individuals should open a Keogh Retirement Plan prior to December 31st, although once opened, contributions may be made until the due date of your return (including extensions). You may contribute to your IRA until the due date of your return (excluding extensions).

Incentive Stock Options

If you have Incentive Stock Options, exercising them is not a taxable event; however, the spread between the option price and the stock price is an item of tax preference under the Alternative Minimum Tax (AMT). For example, if you exercise 1,000 options at $5.00 each (total option price $5,000) and the stock is worth $50 a share (total value $50,000), the spread will be $45,000 for AMT purposes. Calculate the maximum amount you can exercise without triggering tax consequences under the AMT. Use a tax software program or contact a tax preparer regarding this calculation.

Note: Watch out for stock options that produce income to you when exercised, when the underlying stock is "locked-out" of the market (cannot be sold usually for six months). If you exercise stock options in December, you’ll be taxed on the income in 1999, but because of the lock-out, you cannot sell your stock in time to pay your tax liability on April 17, 2000.

Alternative Minimum Tax

If you expect to owe AMT, because of the exercise of incentive stock options or otherwise, consider accelerating income into 1999 -- by receiving bonuses or collecting on accounts receivable, collecting on installment notes, increasing retirement plan or IRA distributions, exercising your ISO and disposing of the stock -- by year’s end. Wait until January, 2000, to pay state income taxes, interest payments on home-equity loans or other expenses which are not deductible in calculating the AMT for 1999.

Annual Minimum Franchise Tax

California charges corporations, limited partnerships and limited liability companies an annual minimum franchise tax of $800 a year. If you have an inactive company, liquidate it prior to the end of the year. You need to file for dissolution with the Secretary of State prior to the end of the year. Check out the new corporate dissolution form which allows a corporate dissolution if the officers merely state that they have paid (or provided for) all the known debts and liabilities, as far as its assets permit.

Likewise, wait until 2000 to form a new entity and save the annual minimum tax otherwise payable in 1999. Note: the minimum corporate franchise tax for certain newly formed corporations will be waived for the first two years. Corporations formed in 1999, however, cannot take advantage of this change, although the minimum tax for a corporation formed in 1999 will be $500, instead of $800. Also, in 2000, LLCs may be comprised of just one member.

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All contents copyright 1995-2003 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.