Temporary Payroll Tax Cut

On December 23, 2011, Congress passed, and the President signed, legislation that extends the 2011 temporary payroll tax cut by two months, to the end of February 2012.  The Federal Insurance Contributions Act (FICA) consist of two separate taxes:  6.20% on the first $106,800 (for 2011) of compensation for Old Age, Survivors and Disability Insurance (OASDI); and 1.45% on all compensation without limit for Medicare Hospital Insurance.  These taxes are imposed on both the employee and the employer.  For 2011, the 6.20% rate was reduced to 4.20% for the employee's share only.  The rate reduction expired December 31, 2011, and Congress squabbled over how to extend the tax cut into 2012.  Congress only managed a two-month extension and so will need to address this issue again shortly.  A similar extension was made for the self-employment tax rate.

In 2012, the OASDI tax applies to the first $110,100 of compensation.  However, the new law only permits the 2% rate cut to apply to the first $18,350 of 2012 compensation (two-twelves of $110,100) during January and February by means of a 2% recapture tax.  This provision prevents those who can control the timing of their compensation from front-loading their compensation to gain the full benefit and also relieves a burden on employers to monitor the tax withholding rate based upon the amount of compensation paid during this two month period.  The recapture tax would be paid on the employee's 2012 income tax return.  However, the recapture provision only applies if the rate cut actually ends on February 29, 2012.  Congress is expected to extend the tax cut to all of 2012.

Last Minute 2011 Year-End Tax Planning

Even at this late date in December, there are "last minute" steps that you can take to save income taxes.  The following bulleted list briefly describes a number of these steps.

1. Determine your 2011 and 2012 marginal income tax rates.  The marginal rate is the tax rate you would pay on the next one dollar of income.  If your 2011 marginal tax rate is lower than what you anticipate for 2012, then try to accelerate income into 2011 and defer deductions into 2012.  Do the reverse if your 2011 tax rate is higher than your 2012 rate.
2. Consider selling stocks for which you have capital losses in order to reduce the amount of your capital gains subject to tax.  Be careful to avoid the "wash sale" rule when reinvesting the sale proceeds.  The wash sale rule prohibits tax losses on the sale if the same security is purchased within the 30-day period before the date of sale and within the 30-day period after the date of sale.
3. Consider converting a portion of your traditional IRA or 401(k) account into a Roth IRA or Roth 401(k) account by December 30th.  The conversion is essentially a question of tax rates in the year of conversion vs. your tax rate in retirement.  If you are in the 15% bracket in 2011, convert enough to fill up the 15% rate bracket which extends to taxable income of $69,000 for joint filers and $34,500 for single filers.  Taxable income is your net income after all deductions and exemptions.  Before converting, be sure that you have enough cash outside the retirement account to pay the conversion tax.  This idea saves future taxes since the Roth account is tax-exempt.
4. For those age 70 1/2 or older, don't forget to receive the 2011 required minimum distribution from your IRA or qualified retirement plan.  Failure to take the RMD incurs a 50% penalty on the amount not taken.  Ending this year is the ability to make a direct charitable contribution from your IRA and have it count as part of your 2011 RMD.  Certain rules and limitations apply.
5. For those who would like to reduce their taxable estate, make a $13,000 present-interest gift to your heirs before the end of the year.  To be considered a completed gift in 2011, gifts made by check should be deposited in the bank by the recipient no later than December 30, 2011.  Each year there is a $13,000 "annual exclusion" from the gift tax.  It is a "use it or lose it" tax benefit.  For a married couple, the gift can be doubled to $26,000 if each spouse participates.

Big tax changes are on the horizon given the need to address the federal budget deficits, and because the so-called Bush tax cuts expire at the end of 2012.  The year 2013 could be the year for important tax changes.  We will keep an eye out on these changes and report on them in future blog posts.

Home Energy Credit Expires After 2011

A personal income tax credit of $500 is available for certain energy-saving home improvements completed by December 31, 2011.  Prior to 2011 the credit was much larger in amount.  The energy credit expires after 2011, so now is the time to complete any needed improvements to your home that can qualify for the tax credit.  This credit has a lifetime limit of $500 of which only $200 may be claimed for windows.  If you claimed this credit in the amount of $500 or more since 2005, no further credit may be claimed in 2011.  The energy credit may offset the 2011 alternative minimum tax.

The 2011 credit is 10% of the cost of certain energy efficient improvements as follows:

1. Insulation, exterior windows and doors, and certain roofs.  The cost of installing these items is not included in the credit calculation.
2. High-efficiency heating and air conditioning systems, water heaters, and stoves that burn biomass fuel.  The cost of installing these items is included in the credit calculation.

Only improvements that meet certain energy savings standards qualify for the credit.  Check the manufacturer's tax credit certification statement before purchasing.

Significant additional tax credits are available for homeowners installing certain alternative energy equipment, such as solar power, geothermal, wind, and fuel cell technologies.  See the IRS website at http://www.irs.gov/newsroom/article/0,,id=249922,00.html for more information.

New Utah Law Regarding Domicile Starts in 2012

Utah imposes an income tax on all of the income of its residents, and upon Utah-sourced income of non-residents.  Intangible income such as interest, dividends, and capital gains on the sale of stock are taxed in the state of residency.  A resident is a person who is either domiciled in Utah or is a statutory resident because the person maintains a place of abode in Utah and has spent more than 182 days in Utah during the calendar year.  Domicile means the location of your permanent home, where you intend to return after being away.  A domicile is not changed to another state unless three conditions are met:  1) you have a specific intention to abandon your current domicile, 2) you establish an actual physical presence in the new domicile, and 3) you intend to remain in the new domicile permanently.  When a person changes their domicile, they will be a part-year Utah resident through the date of the move out of state.

Individuals who may have a large capital gain from the sale of an intangible, such as shares of stock, may try and avoid Utah tax on the gain by moving their residence to another state that does not impose an income tax, such as Nevada, Wyoming, or Texas.  If they are able to successfully change their residence to such a state before selling their stock, they can save Utah tax of 5% of the gain.  Obviously the gain would need to be very substantial to warrant the financial and personal costs of moving.

Utah has enacted a new law that takes effect on January 1, 2012.  The law sets forth some "bright-line" tests for determining whether an individual has a Utah domicile.  The following is a selected list of factors to avoid if you are claiming to no longer be a Utah resident.

1. You or your spouse are claiming resident tuition as a student attending a public university in Utah,
2. You have a dependent who is claimed on your personal federal income tax return who is enrolled in a public kindergarten, elementary, or secondary school in Utah,
3. You or your spouse claim the 45% primary residence exemption from real estate tax on a home in Utah,
4. You or your spouse are registered to vote in Utah,
5. You or your spouse have a Utah driver's license,
6. You or your spouse have a vehicle registered in Utah,
7. The nature and quality of your living accommodations in Utah are superior to those in the other state, and
8. You or your spouse have claimed to be a Utah resident on an income tax return or on a document filed with or provided to a court or other governmental entity.

Other rules and factors apply.  The new law is found in the Utah Code at 59-10-136.

The Utah Educational Section 529 Savings Plan

The Utah Educational Savings Plan (UESP) is a special college expense savings plan authorized under Section 529 under the Internal Revenue Code.  A parent or a grandparent (for example) can open an account for the benefit of a child or grandchild.  Even though the account owner controls the funds, the contribution to the account is treated as a gift qualifying for the annual $13,000 (in 2011-2012) gift tax exclusion amount.  A special election permits up to five years of gifts to be front-loaded.  For example, if a grandfather contributed $65,000 to the account in 2011, the grandfather could not give any more to that grandchild for the years 2011-2015 without consuming part of the his lifetime exemption from gift and estate tax or incurring some gift tax if the exemption was previously utilized.  If the grandfather died during the five-year time period, the portion of the gift relating to future years would be taxable in his estate.

A Section 529 plan has special income tax benefits.  Income and gains in the account are not taxable.  Account withdrawals are not taxable if used to pay for qualifying higher education expenses, such as tuition, fees, books, room and board.  Withdrawals not used to pay qualifying college expenses are subject to income tax.  The portion of the withdrawal attributable to account earnings is included in the account owner's income tax return and also subject to a 10% penalty.  In addition to following the Federal tax benefits, Utah permits a 5% income tax credit on the first $1,740 (single filer) or $3,480 (joint filer) of contributions for 2011 if the account owner is a Utah resident and provided that the beneficiary was under age 19 when named as the account beneficiary.  The dollar limit is indexed for inflation each year.  The credit can be claimed for more than one qualifying beneficiary.  The credit can be claimed even after the beneficiary turns age 19 or older provided the beneficiary was originally named beneficiary before age 19.

The UESP has been highly rated over its low expenses and investment selection.  More information and enrollment can be made at www.uesp.org.

Tax-Free Gains on Qualified Small Business Stock

A brief time window remains for certain new businesses to be organized as a C corporation for which gain realized on the future sale of stock will be exempt from income tax.  A 100% exclusion applies to Qualified Small Business Stock (QSBS) acquired by noncorporate taxpayers during the period of September 28, 2010 through December 31, 2011.  After 2011 the exclusion drops to 50%.  Also, for QSBS acquired after 2011, an alternative minimum tax preference applies to a portion of the excluded gain.  Furthermore, a 28% Federal capital gain tax rate (instead of the usual 15% maximum rate) applies to unexcluded QSBS capital gains after 2011.  The opportunity to exclude capital gains from income tax also applies to purchases of QSBS from existing corporations that meet the requirement.  Some of the basic requirements are the following:

1. The purchase must be of original issue (after August 10, 1993) stock from the corporation in exchange for money, property contributed to the corporation, or services rendered to the corporation,
2. The corporation must be a domestic C corporation and it may not make the S election,
3. Immediately after the stock is issued, and at all times after August 9, 1993 and before the stock is issued, the corporation's total gross assets are and were $50 million or less, and
4. At least 80% of the value of the corporation's assets were used in the active conduct of one or more qualified businesses.

A qualified business is one that is NOT:

1. A service business in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services,
2. A business whose principal asset is the reputation or skill of one or more employees,
3. A banking, insurance, financing, leasing, investing, or similar business,
4. A farming business,
5. A business whose products are eligible for percentage depletion, or
6. A hotel, motel, restaurant, or similar business.

To be eligible for the gain exclusion, the QSBS must have been held for more than 5 years.  In addition, there is a limitation on how much gain can be excluded.  The limitation is the greater of:

1. A lifetime limit of $10 million of gain from the sale of QSBS in the same corporation ($5 million if married filing separately), or
2. Ten times the taxpayer's total adjusted basis in the QSBS sold.

While the tax benefits of investing in QSBS are significant, so are the rules that must be met to qualify.  If you have the opportunity of investing in or establishing a qualified small business, due diligence must be performed in order to ascertain whether the tax rules have been met before you make the investment.

Selected Tax Provisions Expiring at December 31, 2011

The tax code is full of temporary special tax incentives.  Some of the more broad and important provisions that will expire absent Congressional action are shown in the list below.  You should consider taking action before the end of 2011 if you benefit from these incentives.

1. Research credit.  A tax credit is available for research expenditures paid or accrued by December 31, 2011.
2. Bonus depreciation.  Depreciation of 100% of the cost of qualifying property (generally new equipment) is available if it is placed in service by December 31, 2011.  After 2011 the bonus depreciation amount declines to 50% if the property is placed in service by December 31, 2012.  No bonus depreciation applies after 2012.
3. Section 179 expensing.  For tax years beginning in 2011, an election is available under IRC §179 to expense the cost of qualifying property (generally new or used equipment) up to a maximum of $500,000.  The maximum amount is reduced dollar for dollar if the total cost of qualifying property placed in service during the tax year exceeds $2,000,000.  For tax years beginning in 2012 the amounts drop to $139,000 and $560,000 respectively.  For tax years beginning after 2012, the amounts drop again to $25,000 and $200,000 respectively.
4. IRA distributions to charity.  Taxpayers age 70 1/2 or older may make an IRA distribution to charity of up to $100,000 by December 31, 2011.  While the distribution does not count as taxable income or generate a charitable tax deduction, adjusted gross income is reduced which may save taxes under other tax provisions, and importantly, the distribution counts toward the fulfillment of the annual minimum distribution requirement.  This provision was extended through 2011 in late 2010, so the law permitted a taxpayer to elect to treat charitable distributions made during January 2011 as if the distributions occurred in 2010.  If the election was made, care must be taken to avoid including the January 2011 distribution with your total 2011 charitable distribution amount.
5. Purchase qualified small business stock.  Zero tax applies to gain from the sale of QSBS purchased after September 27, 2010 and before January 1, 2012 and held for more than five years.  Many qualifications and limitations apply.  A future blog post will examine this strategy in more detail.

IRS Announces New Voluntary Worker Classification Settlement Program

The IRS announced on September 21, 2011 a new program to help employers resolve past problems in classifying workers as independent contractors instead of employees.  There is not a brightline test in properly classifying workers, and errors can be made.  In addition, workers classified as employees are much more costly to a business than if the workers were instead classified as nonemployees.  Examples of additional costs are payroll taxes, health insurance (if offered to employees), and retirement plan (if offered to employees) contributions.  Therefore, some businesses may have tended toward classifying workers as independent contractors.  If the IRS discovers that workers were misclassified, the IRS can impose years of back taxes, interest, and penalties on the employer.  In addition, the employer could be responsible for past overtime pay, retirement plan contributions, and other employee fringe benefits.  With potential penalties building up over the years, employers felt stuck with the problem without a low-cost way of correcting the misclassification.

The new Voluntary Classification Settlement Program enables eligible employers to obtain substantial relief from past taxes if they prospectively treat workers as employees.  To be eligible, a business must:

1. Have consistently treated the workers in the past as nonemployees,
2. Have filed all required Forms 1099 for the workers for the previous three years,
3. Not be currently under audit by the IRS, and
4. Not be currently under audit by the Department of Labor or by a state agency concerning the classification of these workers.

Eligible employers must file Form 8952 with the IRS at least 60 days before they want to begin treating the workers as employees.  For example, application must be made by November 2, 2011 if the workers are to be reclassified effective January 1, 2012.  Employers accepted into the program will pay a penalty of about 1% of wages paid to the reclassified workers for the past year.  No other interest or penalty will be due, and the IRS will not audit the employer for payroll taxes related to these workers for prior years.  In addition, a six-year (instead of the normal three-year) statute of limitations will apply to the first three years after the start of the program.  Additional information is available on the IRS website at: http://www.irs.gov/businesses/small/article/0,,id=246013,00.html

This is a voluntary Federal program.  Participation in the program could be shared with states that may or may not have a voluntary compliance program of their own.  Note also that correcting worker classification may have an impact under the 2014 health insurance mandate for employers having 50 or more employees beginning in 2013.

Medicare Open Enrollment for 2012 Approaching

Medicare is the Federal government health insurance program for individuals age 65 and older.  Be sure to sign up three months before turning age 65.  The initial enrollment period begins three months before the month you turn age 65 and continues until three months after you turn age 65.  However, if you sign up during the month you turn age 65 (or during the subsequent three-month period), insurance coverage will be delayed.  Medicare has four basic parts.

• Part A is in-patient hospital, skilled nursing facility, hospice, and home health care insurance.
• Part B is medical insurance for doctors and certain preventive care services.
• Part C is also known as Medicare Advantage and permits certain approved private insurance companies to provide benefits otherwise covered by Parts A and B and also usually Part D.
• Part D is for prescription drug coverage.

There are two basic ways of obtaining Medicare coverage:  (1) the original Medicare program of Parts A, B, and D to which so-called Medigap policies can be added; or (2) the Medicare Advantage Plan which is Part C to which Part D may need to be added and to which Medigap policies are not applicable.

Under the original program you pay monthly premiums for Parts B and D and for any Medigap policies.  Under the Medicare Advantage Plan you pay for the overall plan and also for Part D if prescription drug coverage is not part of the overall plan.  Note that premiums charged for Parts B and D are means tested and increase as your adjusted gross income increases.

An open enrollment period for Medicare occurs during the Fall of each year during which you can make changes to your Medicare plans without penalty for the next calendar year.  This year the open enrollment period begins earlier and ends earlier, from October 15, 2011 through December 7, 2011.

Deciding how to obtain Medicare coverage and selecting the underlying policies is a process that takes time and analysis to make the right decision for your circumstances.  For more information see the official government handbook, "Medicare and You" at http://www.medicare.gov/Publications/Pubs/pdf/10050.pdf

Extensions Granted for Certain 2010 Estates

Under the Bush tax cuts that were enacted in 2001, no estate tax was to apply in 2010 and the income tax basis of inherited assets was to generally carryover from the decedent.  On December 17, 2010, Congress acted to extend the Bush tax cuts for two more years and also revamped the 2010 estate tax rules.  The estate tax was retroactively reinstated for 2010 at a 35% tax rate with a $5 million exemption and requiring the income tax basis of assets to be generally changed to their fair market values at the date of death.  In addition, Congress provided an election (for the 2010 tax year only) whereby estates could elect out of the reinstated 2010 estate tax regime and apply the rules of zero estate tax and carryover of income tax basis for inherited property that were originally going to apply for 2010.  The election may be beneficial for large estates.

Tax guidance and tax forms from the IRS have been slow in coming because of the complexity of these changes.  Now, in Notice 2011-76, the IRS has published guidance with respect to the due dates of the required tax forms and reporting obligations.

Estate Tax Return, Form 706:  The due date of estate tax returns of those who died from January 1, 2010 through December 16, 2010 was originally set to be September 19, 2011.  The form was provided less than two weeks ago.  Therefore, if extension Form 4768 is filed by September 19, 2011 for these estates, an extension to March 19, 2012 is permitted for both filing Form 706 and also for paying any estate tax.  However, interest will apply to the estate tax paid after September 19, 2011.  For those who died from December 17, 2010 through December 31, 2010, the regular due date and payment rules apply (nine months after death) unless extension Form 4768 is timely filed, in which case Form 706 and the payment of any tax is due 15 months from the date of death.  Interest will also apply to tax paid after the original nine-month due date, although the Notice waives late payment penalties.

Carryover Basis Return, Form 8939:  For those who died in 2010 and elect out of the reinstated estate tax, the due date of the tax return reporting carryover income tax basis of inherited assets (with adjustments for the special $1.3 million and $4.3 million basis increases) was due November 15, 2011.  The due date is now changed to January 17, 2012 and no extension request is necessary to obtain the later due date.  When carryover basis is elected, the Personal Representative of the estate is required to report the carryover basis information to the estate beneficiaries within 30 days of the due date of Form 8939.  Therefore, the due date for this requirement is also changed, from December 15, 2011 to February 16, 2012 (the Notice states the 17th).

Gains on the Sale of Inherited Assets with Carryover Basis:  Beneficiaries that sell inherited assets may not know the income tax basis of the asset sold by the due date of their 2010 income tax return (October 17, 2011 for extended individual income tax returns) because the due dates of the estate tax return and the carryover basis reporting form may be after the due date of the beneficiary's income tax return.  The beneficiary should make a good faith estimate of the income tax basis and file the income tax return on time.  When the actual basis information becomes available, an amended income tax return will be necessary to correct the basis.  The IRS notice states that underpayment penalties will be waived if a good faith estimate was used.  The amended return should bear the legend, "IR Notice 2011-76" at the top of the form.

The IRS notice does not change other due dates, such as the due date of the gift tax return (Form 709, which is due at the same time as the donor's income tax return) or the due dates of any State inheritance tax forms (Utah follows the Federal law).

IRS Tips for Recently Married Taxpayers

The IRS just published its list of seven tax tips for recently married taxpayers.  I thought it would be good to review these tips as many of our clients have children who are getting married.

1. Report any name change to the Social Security Administration so that your name and Social Security number will match when you file your tax return, or else your tax return will be rejected.  This is the most common mistake.  File Form SS-5 at your local Social Security Administration office.  The form can be found at http://www.ssa.gov/online/ss-5.pdf
2. Notify the IRS of your new address by filing Form 8822.  This form can be found at http://www.irs.gov/pub/irs-pdf/f8822.pdf
3. Notify the U.S. Postal Service of your new address so that your mail can be forwarded.  Notification can be done online at https://moversguide.usps.com/icoa/icoa-main-flow.do?execution=e1s1
4. Notify your employer of any name and address changes so that your Form W-2 will be accurate.
5. Check your wage withholding amounts because each spouse's income will be combined on a joint tax return.  The IRS has a withholding calculator at http://www.irs.gov/individuals/article/0,,id=96196,00.html?portlet=4 which can be used to complete a new Form W-4 to be given to your employer.  The 2011 Form W-4 is available at http://www.irs.gov/pub/irs-pdf/fw4.pdf?portlet=3
6. Choose the correct income tax return form.  The simpler Forms 1040EZ or 1040A may no longer be appropriate, particularly if you will be able to itemize deductions for which the "long form" 1040 is needed.
7. Choose the best filing status.  Your marital status is determined as of December 31 and applies to the whole year.  Usually filing a joint tax return is best, but there are situations for which married filing separate tax returns is better.

Budget Super Committee Introduces Tax Uncertainties

The Budget Control Act of 2011 was signed into law on August 2, 2011, narrowly averting a possible default on repaying U.S. government obligations.  The Act raises the debt limit by $0.9 trillion plus an additional $1.2 to $1.5 trillion depending upon the actions of the super committee.  The Act reduces spending by $0.9 trillion over the next 10 years and creates a 12-member, bi-partisan joint "super" committee charged with making recommendations to cut an additional $1.5 trillion from the deficit over 10 years.  The committee may recommend any combination of spending cuts or tax increases.  If legislation is not enacted by January 15, 2012 to cut the deficit by at least $1.2 trillion, then any shortfall must be taken equally out of defense and social spending by January 1, 2013.  This latter provision is so distasteful to each political party that it is seen as the vehicle to force through an agreement from the super committee.

Super committee appointments are to be made by August 16, 2011 with the first meeting held no later than September 16, 2011.  The committee must vote on their conclusions no later than November 23, 2011.  If a majority votes in favor, then legislative language must be reported out no later then December 2, 2011.  Both the House and the Senate must vote on the proposal by December 23, 2011 with no amendments considered.  The committee may rely on previous proposals to reform spending and taxation due to the time constraint it must work under.  See prior postings dated May 24, 2011, December 6, 2010, and August 30, 2010 for a discussion of these proposals.

When Congress extended the Bush tax cuts at the end of 2010, it was thought that the tax rates could be counted on for at least two more years.  Now with the super committee, its proposals could have effective dates as early as November 2011 rather than January 2013!  It is hard to know what the actual tax proposals will be, if any.  There could be a loss of deductions in exchange for lower tax rates.  There could be an increase on just the so-called "wealthy."  The super committee structure creates uncertainties for taxpayers and businesses with respect to tax planning and budgeting.  In this very politicized environment, to paraphrase Former Speaker Nancy Pelosi when speaking of the health care reform bill, Congress will need to pass the law before we can find out what's in it!

Withholding by Government Entities

If your company sells goods or services to government entities, a new 3% withholding tax will apply beginning on payments received after 2012.  The withholding provision was originally enacted as part of the Tax Increase Prevention and Reconciliation Act of 2005, to be effective in 2011.  The American Recovery and Reinvestment Act of 2009 delayed the effective date to 2012.  Now the IRS has issued final regulations (T.D. 9524) on the matter, further delaying the effective date to 2013.  A additional delay until 2014 is available if your company has a binding contract that is entered into before December 31, 2012.  Certain exceptions are outlined in the regulations.  Legislation was introduced in January 2011 to repeal this withholding provision, but it has not been acted upon.

Government entities are broadly defined to include the federal and state governments, and also political subdivisions and instrumentalities, including public colleges, public universities, and public hospitals.

Withholding is not an additional tax.  It is similar to tax withholding on wages.  While the withholding will have an impact on your cash flow, you will be able to count the withholding as prepaid federal income tax when your tax return is filed for the 2013 tax year.  Changes will need to be made to your internal record keeping systems to identify and track amounts that will be withheld.

UPDATE
On November 21, 2011, the President signed P.L. 112-56 that repeals this 3% withholding law, making the law never in effect.  In its place, Congress enacted a 100% continuous tax levy against federal contractors who are delinquent on their federal taxes.

Taxpayer Identity Theft Rising

The Government Accountability Office recently reported that the IRS is dealing with a near five-fold increase in taxpayer identity theft, rising from 51,702 incidents in 2008 to 248,357 incidents in 2010. However only 4,700 cases were investigated by the IRS.

Thieves are taking taxpayer's tax identification information in order to steal tax refunds.  Thieves file for refunds early in the tax season before the legitimate taxpayer has time to gather records and file tax returns.  In addition, thieves take names and Social Security numbers to gain employment.  Later in the next year, the legitimate taxpayer receives a notice from the IRS that the taxpayer has not reported all of his or her income on the tax return.

If you receive a purported email from the IRS asking for personal information, do not respond, open any attachments, or click on any links.  Instead, forward the message to phishing@irs.gov and then delete the message.  The IRS does not need you to provide your personal identification information, they already have it!  Be careful to safeguard your information by shredding documents rather than just discarding documents containing your information.

If you have been a victim of tax identity theft, contact the IRS Identity Protection Specialized Unit at 800-908-4490.  If your wallet was lost or stolen, you can file Form 14039, Identity Theft Affidavit with the IRS and your account will be marked for review for future questionable activity.  Also consult the Federal Trade Commission's guidance for reporting identity theft at www.ftc.gov/idtheft.

June 30, 2011 Amendment for Cafeteria Plans

Cafeteria plan documents providing for medical flexible spending accounts must be amended by June 30, 2011 to limit the reimbursements to prescribed drugs or insulin.  The cost of over-the-counter drugs may not be reimbursed after 2010.  This change results from the Health Care Reform legislation enacted last year.  The amendment must be retroactive to January 1, 2011 and made by June 30, 2011 according to IRS Notice 2010-59.  The way around this restriction is to receive a prescription from your doctor for the over-the-counter medicine.

Note that the restriction also applies to Health Reimbursement Arrangements (HRAs), Health Savings Accounts (HSAs), and Archer Medical Savings Accounts (Archer MSAs).  If a non-qualifying reimbursement is made by an HSA or an Archer MSA, the reimbursement will be included as taxable income and subject to a 20% tax penalty.

The restriction does not apply to items that are not medicines, such as crutches, bandages, diagnostic devices, etc.

FBAR Due June 30, 2011

U.S. persons having interests in foreign financial accounts must file an annual report with the U.S. government.  The 2010 Report of Foreign Bank and Financial Account (FBAR) must be received by the U.S. Treasury Department in Detroit, Michigan on or before June 30, 2011. The normal postmark rule for timely mailing of tax returns is not applicable. In addition, no extension of time permitted. Owners of entities that are required to file the FBAR must also file FBARs at the owner level if they have more than a 50% direct ownership interest. Significant penalties exist for late or non-filing.

The FBAR is an information return and is filed annually. The FBAR is required for all years in which the maximum bank account value (multiple accounts are aggregated for this purpose) exceeds US$10,000. A year-end exchange rate is used for conversion purposes.  In addition, any account earnings must be included in the U.S. income tax return.

The IRS currently has an amnesty program that provides an incentive for those who have failed to file the FBAR and/or to report the foreign account earnings on their income tax returns.  The program ends on August 31, 2011.  See my posting dated February 28, 2011 for more information.

Corporate Tax Reform Proposals

Various corporation income tax reform proposals have surfaced over the past six months.  At 35%, the U.S. has one of the highest top corporate income tax rates in the world.  However, a tangle of tax deductions, credits, and incentives enable many corporations to pay a much lower effective tax rate.  The impact of the corporate tax varies greatly by industry.  For example, large incentives currently exist for technology, manufacturing, and energy industries and also for multi-national companies.  In addition, income of C corporations is taxed twice:  once at the corporate level and again by shareholders when dividends are paid.

The proposals seek to lower the top rate to somewhere around 25%.  The proposals seek "revenue neutrality" by eliminating many deductions, credits, and incentives.  Thus industries and corporations benefiting the most under current tax law may have the most to lose in corporate tax reform.  Those industries and corporations that pay a higher effective tax rate could see their tax burden drop.  Corporate reform cannot be done in a vacuum.  If individual tax rates remain at 35% or higher, and the corporate rate drops to 25%, there could be a rush to reorganize business tax structures to benefit from the rate reduction.  Therefore, the drive for corporate tax reform could lead to overall fundamental tax reform.

Businesses operated as "pass-through" entities generally only have one-level of income tax which is paid by the owners of the entity.  As a result, there has been a large increase in the number of businesses operated as limited liability companies and S corporations.  The trend toward pass-through entities has caused a sharp drop-off in the amount of corporate income tax collected as a percentage of the gross domestic product (GDP).  According to a Congressional Research Service report, the percentage in the 1950's was around 5% of GDP.  In 2007 it was 2.7% of GDP.  And in 2010 the percentage was 1.3%, also reflecting the impact of the current financial recession.  As a result of this trend, one startling proposal is to tax pass-through entities with gross receipts of $50 million or more as C corporations.  If enacted, this change would have dramatic, adverse impact on many businesses and family organizations that have arranged their affairs to reduce their tax burdens in accordance with current tax law.

Tax Benefits for Heavy SUVs in 2011

Sports utility vehicles having gross vehicle weight (GVW) of over 6,000 pounds are exempt from the so-called "luxury" automobile tax deduction limitations which generally restrict depreciation and Section 179 expensing to very modest amounts.  If the luxury auto is used 100% for business in 2011, then the maximum write-off would be either $3,060 or $11,060; depending upon whether the auto qualified for bonus depreciation.  To qualify for bonus depreciation, the vehicle must be new, meaning its original use begins with the taxpayer.  Under the 2010 Tax Relief Act, the first-year bonus depreciation amount was raised from 50% to 100% for new property acquired and placed in service after 9/8/2010 and before 1/1/2012.  Luxury auto rules limit the amount of bonus depreciation to $8,000.  Since heavy SUVs are exempt from the luxury auto rules, the full cost of the purchase is deductible in 2011 because of 100% bonus depreciation.

Bonus depreciation is different than Section 179 expensing.  Section 179 expensing is available for new or used vehicles, but is limited in amount and is limited to taxable income.  Section 179 expensing limits were greatly enhanced to $500,000 for 2010 and 2011.  However, a special rule limits the Section 179 expensing amount to $25,000 for heavy SUVs rated at 14,000 pounds of GVW or less.  Therefore, bonus depreciation is generally preferable to Section 179 expensing.

The tax deductions must be reduced if the vehicle is not used 100% for business.  In addition, if the vehicle is not used more than 50% for business, it will fail to qualify for both bonus depreciation and Section 179 expensing.

W-2 Reporting of Health Insurance Coverage Delayed

The 2010 health care law imposed a new reporting obligation on employers, to report the aggregate cost of employer-provided health insurance on their employees' W-2s.  This reporting is informational only; not an increase in taxable wages.  The original due date of this reporting obligation began January 1, 2011.  In IRS Notice 2010-69, the IRS made this reporting "optional" for all employers for 2011 W-2s.  Now, in new IRS Notice 2011-28, the IRS extends this voluntary reporting for small employers (those issuing fewer than 250 Forms W-2 for 2011) through 2012.

The aggregate cost to be reported includes both the portion of the premium paid by the employee and the employer, regardless of whether the employee's contributions were made on a pre-tax or an after-tax basis.  However, the aggregate cost does not include contributions to an Archer MSA, Health Savings Account, or a flexible spending arrangement.  Many other special rules exist and reference should be made to IRS guidance for the details.

UPDATE:
IRS Notice 2012-9 extends the exception from reporting employer paid health costs on W-2s for small employers to future tax years beyond 2012 until further guidance is issued by the IRS.

Expanded Form 1099 Reporting Repealed

On April 14, 2011, Pres. Obama signed legislation repealing the expanded Form 1099 reporting requirement that was part of the 2010 health care law.  The expansion was to include information reporting for payments of $600 or more each year to vendors of goods in addition to services, and to also require reporting to corporations (previously exempt from receiving Form 1099s) beginning with payments made in 2012.  The repeal reverts to the former Form 1099 reporting requirements for payments of $600 or more to non-corporations for services (except that payments to corporations for legal services and health care must be reported).

In addition, the expanded Form 1099 reporting requirement for renters of real estate that was enacted as part of the Small Business Jobs Act of 2010 is repealed.  The expansion was to include information reporting for payments of $600 or more each year for vendors of goods in addition to services, and to also require reporting to corporations (previously exempt from receiving Form 1099s), beginning with payments made in 2011.  In addition, the expansion applied to all landlords, not just those who were in the business of renting property.  The repeal reverts to the former Form 1099 reporting requirements for landlords in the business of renting property to report payments of $600 or more to non-corporations for services (except that payments to corporations for legal services and health care must be reported).

Treasury Inspector General Says IRS Should Increase Audits of Tax Returns with Real Estate Rental Losses

In a report dated December 20, 2010, the Treasury Inspector General for Tax Administration (TIG) concluded that 53% of individual taxpayers misreported their rental real estate (RRE) activity.  An estimated $12.4 billion was under reported.  The TIG recommended that the IRS analyze tax returns with RRE losses to determine which returns to include in Compliance Initiative Programs (specialized audits), revise the Form 8582 instructions to require all taxpayers with suspended RRE passive losses to include the form in each year's tax return, and to record which taxpayers claim to be real estate professionals who are exempted from the passive loss limitations.

The IRS is already gathering some additional information on RRE activities by requiring addresses of each property be reported on 2010 tax returns, indicating the type of property (e.g. residential, commercial, etc.), and reporting the number of days rented at fair value or used personally.  In addition, the Small Business Jobs Act of 2010 requires owners of RRE activities to file Form 1099s for all service providers to whom more than $600 is paid, beginning in 2011.

Clearly the government sees some abuses by taxpayers in the tax reporting of RRE activities.  It is important that taxpayers have good records and documentation of income and expenses for each activity, and that they comply with the passive activity loss regulations.  Such records and compliance may be audited more frequently in the future based upon the TIG's recommendations.

Second Chance by Aug 31, 2011 to Disclose Foreign Accounts

US taxpayers are required to disclose to the government their foreign financial accounts and to pay income tax on any earnings each year. Substantial penalties, including the risk of prison under federal criminal prosecution, exist for non-compliance.  Many people either have ignored or were unaware of these duties.  In 2009, the IRS provided a means for such people to come clean under an "Offshore Voluntary Disclosure Initiative."  Some 15,000 people met the October 15, 2009 deadline.  Many others did not.
Now comes round two, and the deadline is August 31, 2011.  The new disclosure initiative requires participants to pay any back taxes, interest, and penalties and to complete the Report of Foreign Bank and Financial Accounts (FBAR) for up to eight years.  In addition, a disclosure penalty of up to 25% of the highest financial account balance during the 2003 to 2010 time frame will be assessed.  By participating in the program, taxpayers have the protection against criminal prosecution, limited financial penalties, and no more than eight tax years to deal with.
The IRS is also encouraging taxpayers who have made so-called "quiet disclosures" to now participate in this new initiative.  A quiet disclosure is a taxpayer's attempt to become compliant by filing amended tax returns without disclosing to the IRS their prior lack of compliance and paying the substantial disclosure penalty.  The IRS says such taxpayers do not have the protection of the voluntary disclosure program and they could be subject to higher penalties, criminal prosecution, and have an unlimited number of tax years subject to examination.
Detailed information for participating the voluntary disclosure program can be found on the IRS website.  The IRS declares that those who don't come forward now to participate in this program will face higher penalties and the possibility of criminal prosecution in the future.

Update:
Taxpayers may request a 90-day extension of the deadline to complete their submission if they can demonstrate a good faith effort to fully comply by the August 31, 2011 deadline.  The request must be made in writing and include a statement of why certain disclosure items are missing and the actions being taken to obtain the missing information.

Second Update:
The IRS extended the August 31, 2011 due date until September 9, 2011 in light of the problems created by Hurricane Irene.

New Exempt Organization Filing Thresholds

The IRS dramatically altered the long-form tax return (Form 990) for tax-exempt organizations in 2008.  Use of the new long-form was phased in over several years because of the increased record keeping and costs of compliance.  For 2010 tax returns, Form 990 must be used by tax-exempt organizations if 2010 gross receipts were $200,000 or more (down from $500,000 for 2009 tax returns) or 2010 ending assets were $500,000 or more (down from $1,250,000 for 2009 tax returns).

The short-form tax return (Form 990-EZ) can be used for 2010 tax returns for those exempt organizations having 2010 gross receipts of less than $200,000 and 2010 ending assets of less than $500,000.

The so-called electronic postcard, Form 990-N, can be used for 2010 tax returns for exempt organizations having 2010 gross receipts not in excess of $50,000 (up from $25,000 for 2009 tax returns).

Private foundations must use Form 990-PF, and there are not shorter, alternative forms based upon the size of gross receipts or total assets of the foundation.

Checklist of "Other" Major 2011 Tax Changes

My recent articles reviewed some of the many tax law changes Congress enacted on December 17, 2010.  The following list highlights many of the other important changes taking effect in 2011, some of which have previously been discussed in earlier blog posts.

1. Tax return preparers must register with the IRS and obtain preparer tax identification numbers in order to prepare tax returns after 2010.
2. Tax return preparers who expect to file 100 or more individual, estate, and trust income tax returns in 2011 must do so by electronically filing the tax returns.  The threshold drops to more than 10 returns in 2012.  Clients may elect to continue to file paper tax returns, but they must sign an IRS-prescribed statement and attach new Form 8948 indicating the reason for not filing electronically.
3. Employers must pay all federal taxes after 2010 using electronic funds transfer.  The old method of making a federal tax deposit at a bank with Form 8109 is no longer permitted.
4. Securities brokers are already required to report the gross proceeds of securities sold.  Beginning in 2011, securities brokers must also report the income tax basis of the securities sold.  Basis must be tracked only for securities purchased after 2010.  The sale proceeds and basis information reporting will enable the IRS to monitor taxpayers' reporting of capital gains and losses.
5. The IRS requires corporations to file information returns reporting the impact on tax basis of stock for any corporate reorganization, such as a stock split, merger, or acquisition occurring after 2010.
6. Financial institutions must file information with the IRS reporting the gross amount of credit and debit card payments a business receives during the year, beginning after 2010.
7. Persons renting real estate to tenants must file Form 1099-MISC for payments totaling $600 or more during the year, beginning after 2010, to service providers such as a plumber, painter, grounds keeper, etc.
8. The penalties for not filing necessary information returns due after 2010 have dramatically increased.
9. The cost of over-the-counter medicines after 2010 can no longer be reimbursed by health flexible spending accounts under cafeteria plans, a health reimbursement plan of the employer, a health savings account (HSA), or an Archer medical savings account.  If a doctor prescribes such medicines, then the cost is eligible for reimbursement.
10. For tax years starting after 2010, the tax penalty on nonqualifying HSA reimbursements increases from 10% to 20%, and the penalty on nonqualifying Archer MSA reimbursements increases from 15% to 20%.