Cover image for The Ernst & Young tax saver's guide 2000
The Ernst & Young tax saver's guide 2000
Richardson, Margaret Milner.
Publication Information:
New York : John Wiley & Sons, [2000]

Physical Description:
xvi, 302 pages : forms ; 20 cm
General Note:
Includes index.
Added Corporate Author:

Format :


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KF6296.A15 E76 2000 Adult Non-Fiction Central Closed Stacks

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"Offers a wealth of tips and advice . . ." --The New York Times Save Money on Your 1999 Taxes

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When you need up-to-the-minute answers to your tax-planning questions, turn to the nation's #1 tax authority: Ernst & Young. Packed with hundreds of unique, money-saving tips, The Ernst & Young Tax Saver's Guide 2000 gives you the lowdown on the latest tax law changes, the leading tax-trimming tips, and the "Changes in the Law You Should Know About" covers new legislation as well as proposed laws that may affect future tax years

"TaxSavers," "TaxAlerts," and "TaxOrganizers" offer helpful tips and reminders Special life-cycle events index helps you minimize taxes associated with marriage, home-buying, retirement, and more Year-round tax-planning strategies and last-minute year-plan now so you don't have to pay later. Put the experience of the leading tax consulting firm to work for you with The Ernst & Young Tax Saver's Guide 2000.

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Author Notes

ERNST & YOUNG LLP is the nation's leading professional services firm, providing tax, assurance, and advisory business services and consulting services to thousands of individuals as well as domestic and global businesses. Visit the firm's Web site at



Chapter One What You Have to Include as Income Introduction The first step in determining how much in taxes you'll have to pay is to figure out your taxable income . That is the amount, figured by subtracting from your gross income certain adjustments and allowable deductions, upon which your tax is based. Your gross income includes income from all sources, including: * Alimony and separate maintenance payments * Compensation for services, including salary, wages, tips, fees, commissions, and certain employee benefits * Gains from dealings in property * Gross income from a business * Income from an interest in an estate or trust * Income from paying off a debt for less than you owe * Certain income from life insurance and endowment contracts * Interest and dividends * Pensions and annuities * Rents and royalties * Court awards in noninjury or nonsickness cases (e.g., job discrimination) * Your share of income from a partnership or S corporation, whether it is distributed or not.     This chapter discusses what you have to include in calculating your taxable income. Along the way, you'll find many tax-saving suggestions that should help you lower your taxable income--and your tax bill. Wages, Salaries, and Other Earned Income As a general rule, you must include in your gross income everything you receive as payment for personal services including wages, salaries, commissions, and tips. If you receive property or services as compensation, you generally should include the fair market value of the property or services as wages in the year you receive it.     Unless you anticipate a tax rate increase next year, you will generally find it to your advantage to defer recognizing income, where permissible, to a later year. Usually the date of receipt determines the year income is taxable. So, failure to cash a check or refusal to accept a payment will not defer income. "Noncash" Compensation. The following are some of the more common forms of noncash compensation that are subject to tax: 1. Employer-provided automobile for personal use. If your employer provided you with a car, your personal use of the car is considered taxable noncash compensation. 2. Educational assistance. You generally must include in income any educational expenses your employer paid for you, unless the courses are required by your employer, are job-related, or the expenses are paid for under a special plan meeting IRS requirements. 3. Bargain purchase of employer's assets. If you are allowed to purchase property from your employer at a price below its fair market value as compensation for your services, you must report as income the difference between the property's fair market value and the amount you paid for it (see the exception following under "Qualified employee discount"). 4. Stock options. The difference between the stock's fair market value and the option price should generally be reported as additional income when you exercise an option to buy stock from your employer. A special rule, however, applies to certain stock options. This rule usually delays the tax until you sell or exchange your stock. (See pages 27-30 in this chapter.) 5. Group term life insurance premiums for over $50,000 of coverage. An employer's payments for group term life insurance premiums for coverage over $50,000 are considered to be additional income to you unless the beneficiary of the "over $50,000 life insurance" is an organization to which a contribution would be a charitable contribution. 6. Club memberships. If your employer provides you with a membership in a country club or similar social organization, you are subject to tax on the value of the membership. Tax-Free Fringe Benefits. Certain fringe benefits you receive from your employer are specifically excluded from taxation. These include: 1. No-additional-cost service. If you receive services from your employer that are regularly offered for sale to customers and your employer incurs no substantial additional cost in providing them to you, you do not have to include the value of these services as income. Example: Stand-by space on flights for airline employees. 2. Qualified employee discount. You do not have to report additional income if the discount your employer extended to you is less than the discount your employer would regularly offer to customers. For the purchase of services, the discount must be less than 20% of the price regularly charged to customers. Example: Appliance retailers' discounted sales of their merchandise to their employees at the lowest discounted price offered to customers. 3. Working condition fringe benefits. You do not have to include in income the value of property or services provided to you by your employer if you would be entitled to a business deduction for such items on your personal return had you paid for these items. Example: Business periodical subscriptions. 4. De minimis fringe benefits. Fringe benefits items so small in value that it would be unreasonable or administratively impractical for your employer to account for them. Examples: Personal use of copying machine, occasional parties for employees. 5. Tax-free employee parking and transit benefits. An exclusion from gross income is allowed for an employee whose employer offers the choice between cash or employer-provided parking, and the employee chooses parking or a transit benefit. If the employee chooses cash, the amount offered is includible in income.     We've mentioned just a few examples. You should consult with your employer and your tax advisor to find out how to treat a particular item. 401(k) Plans. If your employer has a 401(k) plan or another plan that allows you to postpone income, you can elect to defer a certain amount of your salary on a pre-tax basis. Such amounts are withheld from your salary and are not reported as income until withdrawn from the plan. For further information about 401(k)s and other retirement plans, see Chapter 5.     TaxSaver A key element of tax planning is reducing your income. One way to do that is to take advantage of your employer's 401(k) plan, particularly if the deductible amount you are permitted to contribute to an IRA is limited (see pages 87-90). With a 401(k), you can elect to defer up to a maximum of $10,000 in 1999.     Although the funds in your 401(k) plan are meant to be set aside for your retirement, you may still have access to them if you need money. Your plan may permit you to borrow from the plan, subject to strict rules. Despite the restrictions, you may be better off borrowing from your retirement fund than getting a loan from your bank. If the loan from the bank is for personal purposes, it could result in nondeductible interest. While a loan from your 401(k) plan does not generate deductible interest, the interest you pay is allocated to your account (although, of course, your rate of return may be lower than what your assets were earning prior to the loan). Your best bet might be to borrow from the equity in your home. The interest on such a loan would generally be tax deductible. Interest and Dividends Interest that you receive on bank accounts, on loans that you have made to others, or from other sources is taxable. However, interest received on obligations of a state or one of its political subdivisions, the District of Columbia, or a possession of the United States or one of its political divisions is usually tax exempt for federal purposes. Interest paid by the IRS on a tax refund arising from any type of original tax return if the refund is not issued by the 45th day after the later of the due date for the return (determined without regard to any extensions) or the date the return was filed is taxable. (The interest rates on such payments are set periodically by the IRS.) Qualified State Tuition Programs Qualified state tuition programs (QSTPs) are tax exempt. Gifts made to a QSTP are eligible for the gift tax exclusion and the student/participants are not taxed until they receive distributions.     "Qualified higher education expenses" are tuition, fees, books, supplies, equipment required for the enrollment or attendance at a college or university (or certain vocational schools), and room and board. U.S. Saving Bonds U.S. saving bonds are direct obligations of the United States government. Two series of bonds are available: Series EE bonds and Series HH bonds. Both are subject to federal income tax, though in some circumstances (explained below) interest on Series EE bonds may be deferred for many years, and if used for certain educational purposes may even be exempt from tax. Both series of bonds, however, are exempt from state and local income taxes. Series EE Bonds. These are bonds that are issued at a discount--that is, they're purchased at a fixed amount, and are redeemed at a higher amount depending upon how long the bonds are held. Cash method taxpayers have the option of reporting income on the bonds when the bonds are redeemed or reporting it annually as it accrues. Accrual method taxpayers must report the income as it accrues.     TaxSaver Series EE bonds can be an interesting tax-sheltered investment in two ways. First, because most individuals are cash-method taxpayers paying taxes on income as it is received, interest income from Series EE bonds is not recognized until it is received (i.e., when the bonds are redeemed). But, there is a second way you can shelter your interest income from Series EE bonds for an even longer time. If, instead of redeeming the bonds when they come due, you exchange them for Series HH bonds (that pay interest semiannually), you can avoid recognition of the accumulated Series EE bond interest until the Series HH bonds are redeemed.     Example: Clay purchases $7,500 worth of Series EE bonds, which pay interest of 4% per year. In slightly more than seven years, the bonds will have grown in value to $10,000. Instead of redeeming them at that point, he exchanges them for $10,000 worth of Series HH bonds, which pay interest at the rate of 4% per year. The $2,500 of interest income earned over the years on the Series EE bonds would not be taxable at the date of exchange but would be deferred. Clay will receive $400 of taxable interest income per year on the Series HH bonds. The $2,500 of deferred interest income on the Series EE bonds would not be taxable until the Series HH bonds reach final maturity or are redeemed.     There is, however, a limitation on the purchase of EE bonds. An individual may purchase only up to $30,000 per year.     The interest received on EE bonds depends on when the bonds are purchased. Different rules apply to bonds purchased before May 1995, from May 1995 through April 1997, and in May 1997 and beyond. The Treasury site at has more details.     TaxSaver Under current law, interest on EE bonds purchased from January 1, 1990, may be exempt from federal tax, if their redemption proceeds are used for certain educational purposes. To be eligible for the tax exemption, the purchaser of the bonds must be at least 24 years of age, and the proceeds from the sale of the bonds must be used to pay for the qualified higher educational expenses of either the purchaser, his/her spouse, or dependents. The tax break begins to phase out for married taxpayers filing jointly who have adjusted gross income of $79,650 in 1999. For single taxpayers and heads of household filers, the phaseout begins at $53,100. The break is not available if you are married filing separately. Caution: a young couple whose income increases significantly may find that, by the time their child is ready for college, they are no longer eligible to claim the tax exemption. Series HH Bonds.These are current income securities: interest is paid at a fixed rate semiannually. Interest must be reported in the year in which it is received. Since March 1, 1993, new issues have paid a 4% rate of interest. (See discussion above for a tax deferral opportunity using Series EE and Series HH bonds.) You can only get Series HH bonds in exchange for Series E or EE bonds.     TaxSaver Both Series EE and HH bonds are subject to estate, inheritance, gift, or other excise taxes--whether federal or state--but they are exempt from all other taxes imposed on the principal or interest by any state, U.S. possession, or local taxing authority.     TaxSaver Millions of dollars worth of Series (single) E and (single) H saving bonds continue to be held by the public. Most are earning interest. Some, however, have reached final maturity and no longer earn interest,' others are nearing their final maturity dates. The chart below shows the extended maturities that have been announced by the U.S. Treasury. Series E bonds that have reached final maturity should be redeemed or exchanged for Series HH bonds.     Extended maturities Series Date of Issues Interest-bearing Life E May 1941-Nov. 1965 40 years Dec. 1965 and later 30 years H June 1952-Jan. 1957 29 yrs., 8 mos. Feb. 1957 and later 30 years EE All issues 30 years HH All issues 20 years Dividends. Dividends are distributions of money, stock, or other property paid to you by a corporation. You may also indirectly receive dividends through a partnership, an estate, or a trust. In most cases, dividends are taxable as ordinary income. Some dividends, however, are treated as capital gain distributions. The distributions are nontaxable if the distribution is considered to be a return of capital or if the distribution is in the form of stock or stock rights. You should be informed by the corporation making the distribution about the nature and amount of the dividends at the time of distribution. Dividend distributions from a mutual fund, such as interest on dividends earned from the fund's investment securities, are generally considered ordinary income for tax purposes. See Chapter 8, Mutual Funds. Stock Dividends and Stock Rights. Generally, the receipt of stock dividends or stock rights in a company is not taxable, unless the shareholder is permitted to choose between stock (or stock rights) and cash or other property (e.g., a dividend reinvestment plan). If you receive a nontaxable distribution from a company, the adjusted basis of your old stock must be apportioned between the old and the new stock (or stock rights) based on their relative market values. Example: If you owned 100 shares of XYZ Company that you purchased at $10 a share and you then received another 100 shares as a stock dividend, your adjusted basis for your 200 shares would be $5 a share. You are not required to allocate basis to nontaxable stock rights received if the value of the rights is less than 15% of the fair market value of the stock on the date of distribution.     Mutual fund dividends declared in October, November, and December to shareholders of record in those months are considered paid on December 31 of that year even if the distribution isn't actually paid until January of the next year. For a further discussion, see Chapter 8, Mutual Funds. Rental Income and Expenses Rental income includes any payment you receive for the use or occupation of property. If you receive property or services as rent, the fair market value of the property or services you receive is income. (See Chapter 4 for a discussion of vacation home rentals and depreciation issues.) Capital Gains and Losses For the most part, everything you own and hold for personal and investment purposes is a capital asset (See Chapter 7, Capital Gains and Losses, for a discussion of how sales of capital assets are taxed.) Selling Your Home A gain on the sale or exchange (including condemnation) of your principal residence is taxable, although the law provides for a large exclusion. If you have a loss on the sale, under current law you cannot deduct it. (See Chapter 4 for more information about the tax consequences of home ownership as well as for tax-saving strategies that involve your home.) Income from Business and Other Investments Sole Proprietorship, Partnership, and S Corporation Income In a sole proprietorship, you and your business are the same taxpayer. You report gross profit or loss for the year from the sole proprietorship on Form 1040, and it becomes part of your adjusted gross income. In contrast with a sole proprietorship, a partnership is an entity that is separate from the individual taxpayers that are its owners. While a partnership is not an entity subject to federal income tax, if you are a member of a partnership, you are liable individually for tax on your share of partnership income, even if such income is not distributed to you. S corporations generally do not pay federal income tax. Instead, S corporation income typically is taxed directly to the shareholders based on their respective ownership percentage, regardless of whether such income is distributed to them. Like partnerships, S corporations separately report items of income, gain, deduction, and loss that may be subject to special treatment by their shareholders. For a more complete discussion about the taxation of business income, see Part III, Tax Strategies for Businesses, especially Chapter 15, Determining Income, Deductions, and Taxes for Your Business. "At-Risk" Limitation Provisions The deduction for business and other investment losses held directly or through partnerships or S corporations is generally limited to the amount by which you are considered to be "at risk" in the activity. You are considered at risk for the amount of cash you have invested in the venture and the basis of property invested plus certain amounts borrowed for use in the activity.     Borrowed amounts that are considered at risk are (1) loans for which you are personally liable for repayment or (2) loans secured by property, other than that used in the activity. Generally, liabilities that are secured by property within the activity for which you are not otherwise personally liable are not considered to be at risk. An exception: if nonrecourse financing--financing for which you are not personally liable--is secured against real property used in the activity, you may be considered at risk for the amount of the financing.     If you are a partner in a partnership or a shareholder in an S corporation, you are also considered to be at risk for your undistributed share of partnership or S corporation income. The at-risk provisions apply to individuals and closely held corporations (corporations in which five or fewer individuals own more than 50% of the stock). For S corporations or partnerships, the at-risk rules apply to the shareholder or the partner. An exception: closely held corporations engaged in certain equipment leasing and active qualifying businesses are not subject to the at-risk rules.     The law provides a broad list of activities (including the holding of real estate acquired after 1986) that are subject to the at-risk provisions. Each investment activity is considered separately. However, S corporations and partnerships can aggregate investments in similar activity categories. If the "at-risk" provisions apply to you, you should consult with your tax advisor. Passive Activity Losses and Credits Under current law, individuals, estates, trusts, closely held corporations, and personal service corporations are generally prohibited from deducting net losses generated by passive activities. (Passive activities are discussed below.) In addition, tax credits from passive activities are generally limited to the tax liability attributable to such activities. Disallowed passive activity losses are suspended and carded forward to offset passive activity income generated in future years. Similar carryforward treatment applies to excess credits. Defining Passive Activities. A passive activity involves the conduct of any trade or business in which you do not materially participate. You are treated as a material participant only if you are involved in the operations of the activity on a regular, continuous, and substantial basis. If you are not a material participant in an activity, but your spouse is, you are treated as being a material participant and the activity is not considered passive. Seven Tests. The IRS has seven alternative tests you can meet to be considered a material participant. If you satisfy any one of these tests, you will be considered a material participant in an activity. These tests are: 1. You participate in the activity for more than 500 hours during the taxable year; 2. Your participation during the taxable year constitutes substantially all of the participation of all individuals; 3. You participate for more than 100 hours during the taxable year and no one else participates more; 4. The activity is a significant participation activity (SPA) for the taxable year, and your participation in all SPAs during the taxable year exceeds 500 hours. An SPA is an activity in which an individual participates for more than 100 hours, but does not otherwise meet a material participation test; 5. You materially participated in any 5 of the 10 preceding taxable years; 6. The activity is a personal service activity, and you materially participated for any three preceding taxable years. A personal service activity involves performance of personal services in the fields of health, law, engineering, architecture, accounting, actuarial sciences, performing arts, consulting, or any other business in which capital is not a material income-producing factor; and 7. Based on all the facts and circumstances, your participation is regular, continuous, and substantial during the taxable year. Defining an Activity. The proper grouping of business operations into one or more activities is important in determining the allocation of suspended losses, measuring your material participation, separating rental and nonrental activities, and determining when a disposition of an activity has occurred. IRS regulations define an activity as any "appropriate economic unit for measuring gain or loss." What constitutes an "appropriate economic unit" is determined by looking at all facts and circumstances. The regulations list five factors that are to be given the greatest weight. They are: 1. Similarities and differences in types of business; 2. The extent of common control; 3. The extent of common ownership; 4. Geographical location; and 5. Interdependence between the activities.     Generally, taxpayers must be consistent from year to year in determining the business operations that constitute an activity. Furthermore, rental and nonrental activities may only be grouped together in a limited number of circumstances. Consult your tax advisor for more information. Rental Activities. Rental activities are generally considered passive activities. However, the personal use of a dwelling unit for the greater of 14 days or 10% of the time that it is rented out to others is considered use of a personal residence and is not considered a passive activity.     IRS rules provide other exceptions for which activities involving the use of tangible property are not deemed a rental activity.     Real estate professionals who meet certain eligibility thresholds and materially participate in rental real estate activities may offset rental real estate losses against all sources of taxable income.     Only individuals and closely held C corporations can qualify for this special rule. An individual taxpayer will satisfy the eligibility requirements for any tax year if more than one-half of the personal services (with more than 750 hours) performed in trades or businesses by the taxpayer during such a tax year are performed in real property trades or businesses in which the taxpayer materially participates. Personal services performed as an employee are not considered in determining material participation unless the employee has more than a 5% ownership in the employer. However, independent contractor realtor services would qualify for this purpose. For closely held C corporations, the eligibility requirements are met if more than 50% of the corporation's gross receipts for the tax year are derived from real property trades or businesses in which the corporation materially participates. Example: During 1999, a self-employed real estate developer earned $100,000 in fees from projects the developer spent 1,200 hours developing. In addition, the developer incurred rental real estate losses of $200,000 from properties which the developer spent over 800 hours managing during 1999. The developer performs no other personal services during the year and has no other items of income or deduction. Because the developer (1) materially participated in the rental real estate activity, (2) performed more than 750 hours in real property trades or businesses, and (3) performed more than 50% of the developer's total personal service hours in real estate trades or businesses in which the developer materially participated, the developer will have a net operating loss of $100,000 to carry back (and the excess to carry forward) to offset any source of income. Limited Partnerships. Limited partnership interests are considered passive because a limited partner is generally not a material participant. If you have an interest in a limited partnership, you should check with your tax advisor to see if exceptions apply.     In general, working interests in any oil and gas property that you hold directly or through an entity that does not limit your liability is not considered passive, whether or not you are a material participant.     TaxSaver One way to increase the deductibility of your passive activity losses is to convert the interest expense from nondeductible passive activity interest to deductible residential interest. You can accomplish this shift by borrowing against your personal residence and using the proceeds to repay passive activity loans. Interest on borrowings of up to $100,000 secured by your personal residence is usually fully deductible regardless of how the proceeds are used. Exception for Active Real Estate Participation.An exception to the passive loss rules applies to real estate rental activities in which you are an active participant. For this purpose, "active" participation requires a significant but lesser amount of involvement than does "material" participation. Active involvement would include making management decisions such as approving "new tenants" or making capital expenditures. You are considered to have not actively participated in the rental activity if, at any time during the tax year, you own less than a 10% interest in the activity. Each tax year, you can deduct up to $25,000 of passive losses (or claim the equivalent amount of credits) arising from real estate rental activities against income from nonpassive sources, such as salary, interest, and dividends. The $25,000 maximum deduction is reduced (but not below zero) by 50% of the amount by which your adjusted gross income exceeds $100,000. Thus, this deduction is completely phased out if your adjusted gross income is $150,000 or more. Adjusted gross income, for this purpose, is figured without counting taxable Social Security benefits, IRA contribution deductions, and any passive activity loss. Example: Ron's adjusted gross income, figured without taxable Social Security benefits, IRA contribution deductions, and any passive activity loss, is $120,000. He has rental losses of $25,000. If Ron's income had been less than $100,000, he would have been able to deduct the full $25,000 rental real estate loss. Because his income is over $100,000, Ron's $25,000 loss is reduced by $10,000 [50% x ($120,000 - $100,000)]. The disallowed loss of $10,000 can be carried over to future years and deducted (based on these same limitations). Dispositions of Passive Activities. If you completely dispose of a passive activity in a fully taxable transaction, you can then claim previously disallowed (i.e., suspended) losses. In addition, for dispositions made prior to January 1, 1995, if you dispose of a "substantial part" of a passive activity in a fully taxable transaction, you also may be able to deduct the portion of your suspended losses attributable to that part of your investment assuming that you can determine with reasonable certainty the amount of the losses attributable to that part of your investment. For dispositions made after January 1, 1995, you must dispose of "substantially all" of a passive activity in order to deduct that same portion. If you dispose of a passive activity by selling your interest to a related party, you will not be able to deduct any suspended losses until the related purchaser disposes of the interest in a taxable transaction to an unrelated person. You may also be able to deduct suspended losses in a passive activity if your interest is disposed of in various other ways, including abandonment, death of the taxpayer, gifts, and installment sales of entire interests. Special rules may apply. You should consult your tax advisor for further clarification and requirements. (Continues...) Copyright (c) 2000 Ernst & Young. All rights reserved.

Table of Contents

Tax Strategies For Indivduals
What You Have to Include as Income
What You Can Deduct: Exemptions, Adjustments, and Deductions
Travel and Entertainment Expenses
Tax Planning and Your Home
IRAs, 401(k) Plans, and Other Retirement Plans
Charitable Contributions
Capital Gains and Losses
Mutual Funds
Filing Status and How to Calculate Your Tax
Year-End Planning for Individuals
How To Improve Your Financial Future
Investment Planning
Retirement Planning
Estate and Gift Planning
Tax Strategies For Businesses
Some Basic Planning Strategies for Businesses
Determining Income, Deductions, and Taxes for Your Business
S Corporations
Year-End Tax Planning for Businesses
Tax Calendar