It's time for answers to some of your tax questions

A column answering your questions about the business side of your practice

By Cathy B. Goldsticker amednews correspondent— Posted Feb. 19, 2007.

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Question: Included in our practice's 2006 disbursements are premiums paid for "key man" life insurance. I understand that these premiums are not deductible. Does that mean that the proceeds paid at death would be nontaxable income?

Answer: "Key man" life insurance is taken out to protect a business in case of the death of someone deemed hard to replace. Whether insurance proceeds received after the death of the insured are taxable depends upon the organization type of the practice that owns the policy.

It does not matter if your practice is a limited liability company, sole proprietorship, C corporation or S corporation. The insurance premiums will not be deductible.

However, the insurance proceeds received by almost all of these entities will not be taxable for regular tax. But it gets a little more complicated with C corporations.

If you're a C corporation, you will pay alternative minimum tax (AMT) on the insurance proceeds, at a 20% income tax rate. The exception is if you're a small business C corporation, meaning that your receipts for the prior three years average less than $7.5 million a year. Then you get an exclusion from AMT.

C corporations that own life insurance policies and aren't able to take advantage of the exclusion should consider either making an S election or transferring the policies out of the C corporation to protect the proceeds from tax. If your practice is a C corporation holding life insurance policies and may be caught in the AMT tax trap, consult your tax adviser for the best way to avoid the tax bite.

Question: My practice is an S corporation, and I am the only shareholder. I have considered preparing my personal income tax returns for many years, but I have abandoned the idea because of the constantly changing tax laws. Still, I do wish to keep my preparation cost to a minimum. When should I submit my tax information to my tax preparer, and what would be on my "packing list" before I turn it in so I can control my costs?

Answer: There are benefits for submitting tax data early to your tax preparer. Included in these benefits are an earlier completion time, more notice if you owe tax and faster filing to receive quicker tax refunds.

But early submission might come at a higher preparation cost.

The best way to control your costs is to submit all of your tax documents at the same time and make sure the information is complete.

Many tax documents are not received for several months after the year-end, such as K-1 forms from your partnership or LLC investments, which will cause your tax preparer to handle your tax return multiple times.

You can save costs if you submit your income information in an organized and complete fashion. Look at your prior year's tax return, or a current year organizer that provides you with last year's reported income and deductions, to remind you of what items to accumulate.

For example, broker 1099 forms are an important source of income information that will be mailed to you no later than Jan. 31. But frequently they are missing information or include incorrect information, and brokerage firms end up mailing corrected tax forms at a later date.

The Jan. 31 deadline makes it very hard for brokerage houses to accumulate all the necessary information from mutual funds, real estate investment trusts and other investment sources, to determine what are "qualified dividends" and the tax character for various payments, and to handle the massive volume of data.

So submitting corrected tax forms once your tax preparer has started your tax return might increase your preparation costs.

Besides 1099 forms, make sure you accumulate other information from your broker such as investment fees paid during the year, margin interest paid, and federal and state exempt portions of income received, including AMT portions of tax-exempt interest that aren't reported on 1099 forms.

Make sure all your stock sales have associated costs, sale dates and purchase dates. Missing investment activity can cause your tax preparation fee to increase unnecessarily.

On the deduction side, there are many things you can do to control your tax preparation fee. Summarize your charitable deductions instead of submitting multiple charity letters and cancelled checks. Separate cash and noncash donations, and submit the appropriate information for your stock donations.

Submit a listing of the dates and amounts of federal, state and local income tax estimates paid for the tax year.

Accumulate and submit the 1098 tax forms that report your mortgage interest paid. If you are paying interest on more than one home, identify the use of the home, (principal home mortgage, rental home, vacation home, etc.), the amount of the outstanding mortgage balance and how the mortgage proceeds were used. If the mortgage is a result of a current-year refinancing, provide the details of the refinancing transactions.

If you pay for household or child care assistance, provide the wages and associated tax withholdings and state unemployment taxes paid and the recipient's name, federal identification number and address.

Submitting your tax information timely (not too early and not too late) and completely will pay off for you in the end.

Question: When can I start taking distributions from my retirement plan without incurring a penalty?

Answer: Assuming you contributed to your retirement plan and took a tax deduction in the year of contribution, you will pay income tax on the distributions received, regardless of your age or income level. The tax is computed at the ordinary income rates and should be considered when making quarterly income tax estimates, or establishing withholding amounts.

Furthermore, unless you meet an exception, you will incur a 10% early distribution penalty. The penalty exceptions include distributions made after age 59½ (or 55 if you are no longer working), after being disabled, or as part of a series of payments over your life expectancy.

There are also hardship exceptions that will avoid penalties on early distributions. If you need the funds for medical, educational or principal residence purposes, there should not be an extra 10% tax due.

These hardship exceptions apply not only to you, but also to hardships incurred by your spouse, dependents or the primary beneficiary named under your plan.

Cathy B. Goldsticker amednews correspondent—

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