November 2006 News Update

A Tax Credit for Hybrid Auto Buyers

With recent concerns about the cost of fuel, many auto purchasers are considering fuel efficient vehicles that could meet their transportation needs. Hybrid autos have become hot items on buyers’ wish lists. For 2005, a hybrid buyer could take an income-tax deduction of up to $2,000. For 2006 and subsequent years through 2010, however, a tax credit is available for the purchase of a new hybrid. The credit varies from $400 to $3,400, depending on the model of the vehicle.

Many Types of Hybrids

For purposes of the tax credit, hybrids are passenger vehicles or light trucks (8,500 pounds or less in weight) equipped with both a gasoline engine and an electric motor, which is usually recharged as the vehicle is operated.

What About the Credit?

Essentially, the amount of the allowable tax credit will depend on factors such as the vehicle’s weight, its fuel economy, and its lifetime fuel savings. Vehicles using less gasoline will generally qualify for a higher credit amount.

Note that the credit may expire sooner than the end of 2010 for some vehicles. The reason: The tax law provides that, once a manufacturer has sold 60,000 qualifying hybrids, the credit will be phased out over the next five calendar quarters for hybrids sold by that manufacturer.

How S Corporation Income Is Taxed

When it comes to taxes, complicated rules are the norm. So new shareholders of S corporations shouldn’t be surprised to learn that there are some seemingly illogical rules that will govern the way they’ll be taxed on corporate income.

Pass-through treatment. As opposed to a regular corporation’s income, the income of an S corporation generally isn’t taxed at the corporate level. Instead, the income is “passed through” the corporation for inclusion on the shareholders’ returns.

No cash, no tax? Under these rules, shareholders have to report corporate income even if it is not distributed to them. For example, let’s say an S corporation has two 50% shareholders and earns a $100,000 net profit in 2006. The company needs all its cash to fund operations and makes no distributions to the shareholders beyond their regular salaries. Each shareholder would still report $50,000 of income (plus salary) in 2006.

Having to pay taxes on money that hasn’t been received may seem harsh. On the upside, the income will not be subject to taxes again if and when it is distributed. A “basis” calculation required under the tax law serves as a tracking mechanism to prevent S corporation income from being taxed twice. Shareholders receive basis for passed-through income and must reduce basis by cash distributions. Only distributions in excess of basis are subject to taxes.

Questions? Please let us know if you’d like more information about the S corporation rules. We’d be happy to explain them in more detail.

Section 529 Plans Catch a Break

Distributions from Section 529 college savings and prepaid tuition plans are currently excludable from income to the extent the funds are used to pay qualified education expenses, but this tax-free treatment was scheduled to “sunset” after 2010. The income exclusion was recently made permanent.

State Tax Exemption for Retirement Income

A 1996 federal law prohibited states from taxing the retirement income of nonresident retirees. At least one state argued that the tax exemption didn’t apply to retired partners. Now, legislation has clarified that partner-retirees are entitled to the same exemption as retired employees.

Boating Club’s Tax-exempt Status Torpedoed

A tax-exempt boating club owned and maintained a boat house and associated facilities for its members. It also owned shoreline residences, which were leased to club members. When the IRS audited the club recently, it revoked the club’s exempt status because the leasing activities constitute a business.