Harvey & Parmelee LLP
Certified Public Accountants

Updates for Fall 2005

Dear Client:

During the last two months, many changes in income tax law have been implemented. We present below a discussion of some of those changes. We cannot include all of the rules and qualifications for the various provisions discussed, so if you need more detailed information on any of the provisions please call us for more information and to discuss any provisions that might have an effect on you.

IRS loses 30,000 checks. On September 11, 2005, the IRS was transporting checks and its vehicle had an accident. As a result, 30,000 checks ended up in San Francisco Bay. These checks were primarily 3rd quarter estimated tax payments. We have already had confirmation from three of our clients that their checks were among these checks. If your designated address of payment was San Francisco, and if the check for your September 15 estimated tax payment has not been cleared by your bank and returned to you, you might want to review your bank records to determine if your check could have been one of these lost checks. If you think it was, please contact us for assistance or call the IRS at 1-800-829-1040 if you are one of the individuals affected by this mishap. If so, you will need to replace the check as quickly as possible.

Standard mileage rates increase for the last four months of 2005. In response to the high cost of gasoline, the IRS increased the standard mileage rates for business use of an auto to 48.5¢ a mile for business miles driven between Sept. 1 and Dec. 31, 2005. This is 8¢ a mile more than the 40.5¢ per mile rate that applies for business miles driven between Jan. 1 and Aug. 31, 2005. The IRS also increased the standard mileage rate for computing deductible medical or moving expenses to 22¢ a mile for miles driven between Sept. 1 and Dec. 31, 2005. This is 7¢ a mile more than the 15¢ per mile rate that applies during the first eight months of 2005.

New form for qualified vehicle donations. Under new rules that first apply for 2005 contributions, the deduction for "qualified vehicles" (motor vehicles, boats and planes that aren't inventory or held for sale in the ordinary course of business) contributed to charity for which the claimed value exceeds $500 is dependent on the charity's use of the donated property. If the charity sells the vehicle without any "significant intervening use" or "material improvement," or transfers it to other than a needy person at a price significantly below fair market value in furtherance of its charitable purpose, your charitable deduction can't exceed the charity's gross proceeds from the sale. The IRS has released new Form 1098-C, Contributions of Motor Vehicles, Boats, and Airplanes. Charities must use Copy A of this form to report donations of qualified vehicles with a claimed value of more than $500 to the IRS. In addition, they can use Copy B and C of the form to provide a contemporaneous written acknowledgment to donors, who must attach Copy B (or any alternative acknowledgment provided by the donor) to their Federal income tax return in order to claim a charitable deduction for such qualified vehicle donations. Copy C can be retained by the donor.

New energy tax breaks. During August, the "Energy Tax Incentives Act of 2005" was signed into law. It contains tax incentives designed to improve energy production, transportation and efficiency. These tax breaks generally first apply in 2006 and include tax credits for:

• builders to construct energy efficient homes (plus deductions to design and build energy efficient buildings);
• individuals to make energy saving improvements to their residences;
• individuals to buy vehicles powered by alternative fuels;
• manufacturers to make energy saving dishwashers, clothes washers, and refrigerators

Legislative and administrative Hurricane Katrina tax relief. During September, the Katrina Emergency Tax Relief Act of 2005 ("KETRA") was signed into law. Despite its title, it contains provisions that apply to all taxpayers and some provisions that apply just to Katrina victims. These include:

• some penalty-free IRA and qualified retirement plan distributions for disaster victims,
• eligibility to take a larger loan from a retirement plan without adverse tax consequences, for disaster victims
• a credit for hiring workers who are victims of Hurricane Katrina,
• a limited exemption for housing Katrina victims for 2005 and 2006 of $500 per person up to $2,000,
• eased charitable deduction limits for all taxpayers for qualified disaster contributions,
• increased cents per mile deduction for charitable use of an auto for Katrina relief at 34 cents/mile instead of the normal 14 cents/mile,
• deduction of casualty losses without the normal $100 and 10% exclusion,
• exclusion from income of debt relief for disaster victims
• longer replacement period for deferring gain on involuntarily converted property of up to five years for victims

Advance look at some 2006 limits. There is good news for gift givers-the gift tax annual exclusion will increase to $12,000 from $11,000. The standard deduction will increase to $10,300 for joint filers and $5,150 for singles and separate filers and the personal exemption will rise to $3,300. On the education front, for 2006, the Hope credit will be 100% of up to $1,100 of qualified higher education tuition and related expenses plus 50% of the next $1,100 of such expenses.

Taxpayers lose in an important family limited partnership (FLP) case. Individuals sometimes transfer assets to an FLP in the hope of achieving large estate tax discounts for the assets that would not otherwise be available if the assets were retained in outright ownership. The huge discounts, in turn, can result in substantial estate tax savings. However, in order to achieve the desired result, among other things, the individual must give up control of the transferred assets or the property will be brought back into his estate under a complex statutory provision. That's exactly what happened in a very important case decided this past summer in the IRS's favor. This case, which started out as Estate of Strangi (the individual who created the FLP) and ended up as Gulig (his son-in-law and attorney) found that there was an "implied agreement" between Mr. Strangi and his relatives for him to retain possession of the property after he transferred it to the FLP. This case, which is famous in estate planning circles, shows what not to do when structuring an FLP to achieve estate tax savings.

Open assessment period for some responsible persons. The IRS recently asserted that a "responsible person" liable for the trust fund recovery penalty (related to payment of payroll taxes) is subject to the same assessment period that applies to the employer's return. Thus, where the employer has committed fraud, willfully attempted to evade tax, or failed to file an employment tax return, an unlimited assessment period applies to the responsible person. Due to the enormous potential for substantial liability, anyone who is responsible for collecting, accounting for and paying payroll taxes (e.g., officers, directors, accountants, or shareholders) must be constantly vigilant that the proper employment taxes are paid. This is especially so under the recent IRS position, which if sustained, will continue the period of exposure indefinitely in a good number of cases.

Increased S corporation compliance. The IRS announced the launch of a new study to assess the reporting compliance of S corporations, which have grown significantly in number in recent years. The study will examine 5,000 randomly selected S corporation returns from tax years 2003 and 2004.

Please contact us if you need additional information on any of these provisions or if you need to discuss them with us.

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