Robert H. Gray, CPA

While investment clubs provide an opportunity for friends or family to meet, learn about investments, and make money, it’s best to treat a club as you would any other business relationship.

Written agreement. Most clubs are formed as partnerships. Every partnership should consider adopting a written partnership agreement.

This legal contract outlines how the business will operate and how profits and losses will be allocated among the partners.

In the beginning, your investment may seem small, and it’s easy to dismiss the need for this document. However, a successful club can accumulate substantial assets. Having this document in place from the beginning can prevent problems later, such as how to liquidate a partner’s interest when one leaves.

Taxes. Partnerships don’t pay income tax, but they must file an annual return with the IRS. They must also provide a Form K-1 to each partner. This form reports each partner’s share of income and deductions, which the partner must include on his/her individual income tax return. If the partnership fails to file a return, the IRS can assess a late filing penalty of up to $89 per month per partner for a maximum of 12 months.

Duties. As in any business, it’s a good idea for club members to share financial duties. Consider requiring two signatures to transfer funds between accounts. Periodically review the treasurer’s records to make sure that transactions were properly authorized by the club, that the recordkeeping is adequate, that tax returns were filed, and that all money and stocks are properly accounted for.

An investment club that gets off to a good start has a much better chance of a long and successful existence.

These days, charities need your support more than ever. As you lend a helping hand, keep the following tax facts in mind.

• If you itemize, you may deduct cash contributions to qualified charities, as well as the fair market value of donated property.
• Contributions to religious institutions and large, national charities usually qualify for tax deductibility, while contributions to individuals don’t. If you have any doubts, check with the IRS to see if your charity is on the list of qualified tax-exempt organizations.
• When you donate brand-new merchandise or stocks and bonds that are publicly traded, it’s relatively easy to determine market value. But what’s the value of used clothing, furniture, or appliances? According to the IRS, you may take a deduction for used clothing and household items only if they are in “good” condition.
• The value of your charitable services is not deductible, but you can deduct out-of-pocket and incidental expenses. Example: You drive to a charity dinner, help out in the kitchen, and donate your favorite casserole. You can deduct the cost of the food and your charitable mileage, but not the value of your time.
• Instead of contributing cash, consider donating stock, mutual funds, artwork, or similar items that have increased in value. You may deduct the full market value of the property, and you’ll avoid paying tax on the built-in capital gain.
• With securities that have decreased in value, it’s better to sell the securities first and donate the proceeds. That way, you can deduct both your charitable contribution and your capital loss on the sale.
• If you plan to make a large contribution to charity, seek tax advice before rather than after making the gift in order to maximize your tax benefits.

Good recordkeeping is required

If you plan to claim a tax deduction for charitable contributions, you need documentation to support your gift. Here are the IRS requirements:

• Under prior tax law, cash donations over $250 had to be documented by the charity. Now that dollar threshold no longer applies: cash, check, and other monetary donations of any amount can be deducted only if substantiated by a bank record or written documentation from the charity.
• If you donate used clothing or household items, you may claim a deduction only if the items are in “good” condition.
• If you contribute property with a value above $500, your personal records must also include details of how and when you acquired the property and your cost basis in the property.
• If you donate an item or a group of similar items worth more than $5,000, all of the previous requirements apply, but you must also obtain a qualified appraisal. There are special exceptions for publicly traded stock and, in some cases, for nonpublic stock.
• If you receive anything of value in return for your donation (“quid pro quo” contributions), your deduction is limited to the difference between what you donate and what you receive.
  For all quid pro quo donations over $75, the charity must provide you with a written disclosure of the value of the goods or services provided and must indicate that the deduction is limited to the difference between the donation and the value stated.

On the Chinese calendar, 2010 is the Year of the Tiger. On the U.S. tax calendar, 2010 may be the Year of the Roth. Why? Because Roth IRAs become more accessible this year. The previous $100,000 income limit restricting the conversion from a traditional IRA to a Roth is repealed. Effective January 1, 2010, you may convert to a Roth no matter what your income is.

The change comes from the Tax Increase Prevention and Reconciliation Act (TIPRA), a law signed in 2006. TIPRA also eliminates the prohibition against converting to a Roth for those married taxpayers who file separate returns. Those individuals will be able to take advantage of the new rules too.

The first question to ask

Is converting a good idea? If it made sense before and you were unable to do so only because of the income limitation, the answer is probably yes. Switching gives you access to the benefits of Roth accounts. Those benefits include tax- and penalty-free distributions, both of which generally kick in once you’re 59½ and have met the five-year holding requirement.

In addition, Roths offer estate planning advantages. For example, unlike traditional IRAs, you’re not required to withdraw specified amounts from a Roth each year once you reach age 70½. The same is true when your spouse inherits the account as your designated beneficiary. Other heirs must take distributions, but the account balance can typically be withdrawn over a number of years.

The conversion to a Roth does have a cost. When you have no basis in your traditional IRA – for instance, you deducted your original contributions on prior tax returns – you’ll have to add the entire amount converted to your taxable income. The increase in income could have tax and nontax implications, such as reducing itemized deductions or affecting college financial aid.

Fortunately, TIPRA provides a one-time incentive to do a traditional to Roth IRA conversion in 2010.

The incentive works this way

If you want to do a conversion, here’s a reason to consider doing it in 2010. You do not have to include the taxable portion of the conversion in your 2010 income. Instead you are allowed to report half of the income on your 2011 tax return and the remaining half on your 2012 tax return.

The deferral gives you a multi-year period to plan for, and pay, the tax. Just be aware that taking distributions from converted funds may have tax consequences.

You can also choose to pay more quickly by making an election to report all of the conversion on your 2010 return. While prepaying seems counterintuitive, remember that present federal tax rates are set to expire December 31, 2010. Postponing income into future years could mean a bigger tax bill.

Your plans for retirement

There’s another way tax rates can affect your decision about converting. Say you intend to retire and relocate to a state with low or no income tax, and you expect the move to reduce your overall tax rate. In that case, you may decide to delay or forgo making a conversion.

Converting involves other variables too, and it’s important to weigh the pros and cons in your individual situation. Please give us a call if you would like to discuss the best strategy for you.

In your tax planning, don’t overlook how your tax-saving strategies might be affected by the alternative minimum tax.

What is the alternative minimum tax?

Enacted back in 1969, the alternative minimum tax (AMT) was designed to make sure that high-income taxpayers pay a minimum amount of taxes, even if they have sufficient deductions and credits to reduce their federal income tax liability to zero.

The AMT is like a flat tax. You get a lower tax rate in exchange for losing most deductions.

To calculate the AMT, start with regular taxable income, which includes all your familiar deductions and exemptions. Then make certain adjustments and add back certain “preferences” to arrive at your AMT income. Preferences include personal exemptions, state and local taxes, certain interest on home-equity loans, and miscellaneous itemized deductions.

After adding back the preferences, you’re entitled to an exemption amount, though the exemption phases out at higher-income levels.

You then calculate your AMT by applying a tax rate of 26 percent to the first $175,000 of AMT taxable income, and 28 percent to any additional amounts. Finally, you compare your AMT to your regular tax and pay whichever is greater.

Who is affected by the AMT?

Congress created the AMT to ensure that wealthier taxpayers, who often have the kinds of income and deductions that qualify for preferential tax treatment, would pay at least a minimum amount of tax. Congress also wrote exemptions into the law, so that middle-income taxpayers wouldn’t be subject to the AMT.

Unfortunately, these exemptions were not indexed for inflation. As incomes have continued to rise, more and more people have found that they need to calculate their tax bill twice — once under regular tax rules, and again under the AMT.

Though Congress has expressed a desire to eliminate the AMT, it is still in effect. Every year thousands of middle-income taxpayers find themselves subject to the alternative minimum tax.

Will the AMT affect you?

Do you need to concern yourself with the AMT? You do if you have a lot of dependents or if you claim substantial itemized deductions. You may also be subject to the AMT if you realized hefty capital gains during the year or exercised incentive stock options. Claiming certain tax credits might trigger the AMT as well. And if you are an owner of rental real estate or a capital intensive business, you need to be aware that the amount of depreciation allowed under the AMT is limited.

Don’t forget the AMT in your tax planning. You may be one of those middle-income taxpayers who is now subject to this tax.