Selections from the IRS’ Year End Guidance on Affordable Care Act Issues

The IRS issued Notice 2015-87 in the middle of December and Notice 2016-4 at the end of December.  They provide guidance on a variety of complicated issues pertaining to the ACA.  A few of these issues to take note of are: 

1.     Health reimbursement accounts (HRAs) are written plans where an employer agrees to reimburse certain health care costs of employees.  Such reimbursements are income tax free to the employee.  Except in a C corporation scenario, the tax-free nature of the reimbursements is not generally available to owner-employees.  Stand-alone HRAs are no longer permitted by the ACA unless they reimburse only excepted benefits.  Benefits excepted from the ACA’s market reform rules include dental or vision coverage.  If the HRA reimburses other health care costs such as co-pays or deductibles, the HRA must be integrated with a qualifying group health insurance policy.  If it is not, the employer is subject to a $100 per day per employee penalty, generally capped at $500,000 per year per entity.

2.     An HRA that covers fewer than two current employees is not subject to the ACA’s marketplace reform rules.  In this circumstance, the HRA can cover any health care cost and avoid the $100 per day penalty.

3.     The IRS clarified a fine point relating to HRAs that are integrated with a group policy.  The HRA loses its integration if the arrangement reimburses individuals not covered by the group policy.  For example, if an employee chooses self-only coverage, the HRA may not reimburse the health costs of the employee’s spouse and/or dependents because they are not covered by the group health insurance policy.  The IRS offers transition relief that ignores this violation through 2015 to give time for employers to come into compliance.

4.     The ACA requires applicable large employers to offer “affordable” health insurance to full time employees or face a penalty.  The law states that an employee’s share of the group policy premium must not exceed 9.5% of household income to be deemed affordable.  Because an employer will not know an employee’s household income, the IRS has provided several safe harbors to determine affordability.  One safe harbor is 9.5% of the employee’s W-2 compensation.  The 9.5% rate is adjusted for inflation.  For 2015 the percentage is 9.56% and for 2016 the percentage is 9.66%.

5.     An applicable large employer will be penalized for failing to offer health insurance if at least one full-time employee obtains health insurance on the exchange and receives a premium tax credit.  The penalty amount is $2,000 times the total number of full-time employees in excess of 30 (80 for 2015).  The penalty amount is indexed for inflation.  For 2015 the penalty is $2,080 and for 2016 the penalty is $2,160.

6.     An applicable large employer will also be penalized for failing to offer health insurance that is “affordable” or failing to at least meet the “bronze” level of benefits if at least one full-time employee obtains health insurance on the exchange and receives a premium tax credit.  The penalty amount is $3,000 times the number of full-time employees receiving such credits.  The penalty amount is indexed for inflation.  For 2015 the penalty is $3,120 and for 2016 the penalty is $3,240.

7.     In Notice 2015-87 the IRS states that it will not impose penalties on employers who make good faith efforts to comply with the ACA’s information reporting requirements for 2015 but who nevertheless make inaccuracies in the tax forms or miss the due date.  The penalty is up to $250 per form up to a maximum of $3 million!  In Notice 2016-4 the IRS extends the due dates for 2015 reporting.  Applicable large employers are now required to provide Form 1095-C by March 31, 2016 (instead of February 1, 2016) to employees and to file Form 1094-C by May 31, 2016 if filed on paper (instead of February 29, 2016) or by June 30, 2016 if filed electronically (instead of March 31, 2016) with the IRS.
There is no penalty waiver for failure to meet the due date unless there is reasonable cause for the failure.  Normally an extension of time should be requested.  However, for the 2015 Forms 1095-C and 1094-C the IRS has extended the due dates beyond the normal extended due dates.  Therefore, the IRS states that it will not grant any extension of the new 2015 due dates, but it will consider reasonable cause for late filing.  Factors taken into account for establishing reasonable cause include whether the employer made reasonable efforts to gather and transmit the necessary data to an agent to prepare the data for submission to the IRS and whether steps are being taken to ensure that the employer will be able to timely comply with next year’s reporting requirements.

8.     Now that the IRS has extended the ACA information reporting due dates, some individuals will file their 2015 income returns before receiving their ACA tax forms.  If such individuals have relied upon other information received from employers, or from health insurance providers, they will not be required to amend their income tax returns once they receive their Forms 1095-B or 1095-C, including any corrected forms.  However, the IRS has not extended the due dates for the Health Insurance Marketplace (or Exchange) to issue Form 1095-A.  Individuals who enrolled for coverage through the Marketplace should receive Form 1095-A by February 1, 2016 and should wait to file their tax returns until they receive their Form 1095-A.

Last Minute 2015 Personal Tax Planning

Consider implementing the following strategies by December 31st to save income taxes.  The income tax laws are now so complex that it is difficult to know whether any of these general recommendations will actually save you tax without undertaking a computerized tax projection.  You should consult your tax advisor before implementing these ideas. 

·       If you are in the upper tax brackets, harvest capital losses as necessary to reduce capital gains tax, and to lower the Affordable Care Act’s tax on net investment income.  Generally, short-term losses are preferred over long-term losses because short-term gains bear a higher tax rate than long-term gains.  Be sure to specifically identify the block of securities you are selling to your broker.  Don’t trigger capital losses if you are in a low tax bracket.  Be sure to avoid the “wash sale” rule that applies if you purchase substantially identical replacement securities within 30 days before or 30 days after the date of sale.

·       If you are in the lower tax brackets, harvest long-term capital gains as necessary to fill in the lower tax brackets.  For example, a zero percent long-term capital gain tax rate applies through $74,900 of taxable income for joint tax returns!  However, ordinary income fills up the low brackets first, so some coordination is necessary to achieve a zero percent tax rate.

·       Be sure that any year-end charitable donations are either delivered or mailed and postmarked by December 31st.  Be sure that you obtain the required tax-qualified receipt early next year so that documentation is available when preparation of your income tax return begins.  If you want a charitable deduction but are not prepared to actually give the funds to a charity at this time, consider using a donor advised fund (DAF) to claim the deduction now.  You can select the charity later and “advise” the DAF to contribute to the charity then.

·       For those at least age 70 ½, consider using your traditional IRA to make a direct charitable donation of up to $100,000 to a public charity (but not a DAF).  This provision had expired at the end of 2014 but was just retroactively reinstated for 2015 donations and has now been made permanent.  The charitable IRA donation is also considered a distribution for purposes of your 2015 minimum required distribution.  Coupled with the phase out of itemized deductions, personal exemptions, and the net investment income tax, the charitable IRA donation can be effective in lowering your overall income tax.  This strategy is also very effective for Social Security recipients whose benefits are not fully subject to income tax.

·       Consider donating any long-term appreciated securities to charity.  You can claim a tax deduction equal to the fair market value of the securities without triggering tax on the capital gain.

·       For those at least age 70 ½, and for those of any age who have inherited an IRA, don’t forget to take your minimum required distribution by December 31st to avoid a 50% penalty.

·       Prepay state income tax unless you are subject to the alternative minimum tax (AMT).  Taxes are not deductible for the AMT.

·       Consider accelerating ordinary income into 2015 if you are subject to the AMT and may not be in 2016.  The top AMT tax rate is lower than the top ordinary tax rate.

·       If you exercised incentive stock options (ISOs) in 2015 and the value of the stock has dropped, consider selling the ISO stock by year-end in order to purge the AMT ISO adjustment so that you don’t pay tax on value that has disappeared.

·       Consider making a Roth IRA conversion if you are in a low tax bracket this year.

·       Keep a focus on your adjusted gross income (AGI).  Many deductions and credits are lost, and additional taxes can apply, depending on the size of your AGI.  Lost tax benefits due to high AGI include the deduction of personal exemptions, itemized deductions, some IRA deductions, the ability to contribute to a Roth IRA, educational credits, taxation of Social Security benefits, and Affordable Care Act taxes.  Therefore, it generally makes sense to keep your AGI as low as possible.

·       For purposes of gift and estate tax planning, don’t forget to use the $14,000 annual exclusion.  Giving cashier checks is advisable when cash gifts are made at year end to be sure that the gift is completed in the 2015 calendar year.

Last Minute 2015 Business Tax Planning

Businesses have another week until December 31, 2015, to implement any “last minute” income tax planning strategies. Here is a checklist of several strategies applicable to businesses: 

·       50% first-year bonus depreciation has been extended to include qualified property acquired and placed in service by December 31, 2015 (previously expired after 2014 and expiring once more after a phase-out period of 2018-2019).  The property’s original use must begin with the taxpayer (new property).

·       The higher Section 179 business expensing limits have been extended to include qualifying property (new or used) acquired and placed in service in tax years beginning in 2015 (previously expired for tax years beginning after 2014 but now made permanent).  The expensing limit is restored to $500,000; phasing out dollar for dollar as purchases exceed $2,000,000.  These limits are now indexed for inflation beginning in 2016.  Previously these limits would have been $25,000 and $200,000 respectively.

·       Adopt a qualified retirement plan, such as a profit sharing plan, a 401(k) plan, or a defined benefit plan by December 31st.  Alternatively, a simplified employee pension (SEP) plan can be adopted by the due date of the tax return (with extensions).

·       Estimate the business’ marginal income tax rate for 2015 and 2016 and shift income and deductions as appropriate to allow more income to be taxed at lower tax rates, or to allow more deductions to be claimed at higher tax rates.

·       Personal service (in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting) C corporations (PSC) are subject to a flat income tax rate of 35% where substantially all of the shareholders are employees.  Such corporations and shareholders will generally save income taxes by zeroing out corporate taxable income by year-end bonuses to the shareholder-employees.

·       Cash basis taxpayers should pay and mail all outstanding bills and payroll by December 31st.

·       Accrual basis corporations should declare and accrue bonuses by December 31st as long as actual payment occurs no later than March 15, 2016.  A special rule applies to shareholders owning directly or indirectly more than 50% of a C corporation’s stock.  The special rule also applies to any PSC shareholder-employee and to any S corporation shareholder-employee.  Under the special rule, bonuses must be paid by December 31st to be deductible in 2015 (essentially being placed on the cash method).

·       Write-down the value of subnormal inventory items.  Subnormal items are goods that are unsalable at normal prices or unusable in the normal way due to damage, imperfections, shop wear, changes of style, odd or broken lots, or other similar causes.  You can take a deduction for any write-downs provided you offer to sell the items at the new price within 30 days of your inventory date. However, the inventory does not actually have to be sold within the 30-day time frame.

·       If you own an interest in a partnership or an S corporation, you may need to increase your tax basis in the entity in order to deduct a loss from it for this year.

·       If you do not already have an existing policy, be sure that a written capitalization policy is in place by December 31, 2015 for the 2016 tax year.  This policy permits low-cost asset purchases ($2,500 or up to $5,000 for audited financial statements) to be expensed in the income statement instead of capitalized on to the balance sheet and depreciated.  Your financial accounting records must also treat these low-cost asset purchases as expenses.  While an annual election in the income tax return must be made each year to claim the deduction, it does not appear that a new capitalization policy must be adopted each year.  Rather, a written capitalization policy simply must be in place before the start of the tax year for which you are making the tax return election.  Technically the accounting policy only needs to be in writing for the $5,000 limit for audited statements, but it is a good practice for all businesses to follow.

Selected Business Tax Provisions of the “Protecting Americans from Tax Hikes Act of 2015”

On December 16^th, the Senate Finance Committee and the House Ways and Means Committee agreed on tax legislation extending many tax provisions that had expired at the end of 2014, making some of the provisions permanent.  Making some provisions permanent brings more certainty to the tax code and will help businesses make financial decisions and plan for the future. 

Selected expired provisions retroactively reinstated for 2015 and made permanent include: 

1.      The enhanced expensing election under Section 179 for the cost of purchasing new or used machinery, equipment, and other business personal property and certain qualified real estate improvements.  The expensing limit had dropped in 2015 to $25,000 with the limit being phased out, dollar for dollar, as the total amount of property placed in service during the year exceeded $200,000.  Now the enhanced limits of $500,000 and $2,000,000 are reinstated for tax years beginning after 2014 and indexed for inflation beginning in 2016.  In addition, computer software is eligible for Section 179 expensing and the election can be revoked without IRS consent.  Furthermore, the $250,000 cap on the portion of the $500,000 expensing limit that could be used for qualified real estate improvements has now been removed so that the full expensing limit is available.  Finally, for property placed in service after 2015, air conditioning and heating units are considered eligible Section 179 property.

2.      The reduced depreciation period from 39 years to 15 years for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements.  This change significantly improves the present value of the tax depreciation benefits.  Be sure to check the qualification requirements.

3.      The research tax credit is reinstated for amounts paid or incurred after 2014.  Taxpayers with fiscal years beginning in 2014 and ending in 2015 and who have already filed their tax return should consider amending their tax return to claim the credit on 2015 expenses.  In addition to reinstating the credit, significant improvements have been made to the usability of the credit.  For tax years beginning after 2015, small businesses having $50 million or less of gross receipts may claim the credit against their alternative minimum tax (AMT), thus permitting the credit to reduce tax expense when businesses pay the AMT instead of regular tax.  And in an important change for start-up businesses having less than $5 million of gross receipts and that don’t yet have profits and therefore income tax liability to be able to use the credit, up to $250,000 of credit per year can be used to offset the employer FICA-match tax liability starting with tax years beginning after 2015, thus making the credit refundable for these businesses.  As a further requirement, the payroll tax credit is not available if the start-up business had gross receipts for any tax year preceding the 5-taxable year period ending with the year of the credit.

4.      The reduction of the S corporation recognition period from 10 years to 5 years for built-in gains (BIG) tax.  When a C corporation elects to become an S corporation, the double taxation associated with C corporations will end as the S corporation is a “pass-through” entity and only the shareholder(s) pay income tax, not the corporation.  To prevent a C corporation from making an S election just prior to the sale of assets in order to avoid double taxation, a BIG tax is imposed upon the new S corporation if assets or sold or income is recognized during the first 5 years following the election.  The BIG is the excess of the fair market value of assets (including goodwill and cash basis receivables) over their income tax bases on the effective date of the S election.  The tax rate on the BIG is the highest C corporation tax rate in effect.

5.      The basis reduction to stock of S corporations making charitable contributions of appreciated property is now the tax basis of the property donated and not the fair market value deduction.

6.      The exclusion of 100% of the gain on the sale of certain qualified small business stock acquired after 2014 and owned longer than 5 years, both for income tax and for AMT.  The exclusion is limited to the greater of $10 million or 10 times the adjusted tax basis of the stock sold.  The exclusion percentage had dropped to 50% with a 7% AMT preference.  Among other requirements, in general, the stock must have been acquired directly from the corporation (original issue), the corporation must be a C corporation conducting an active trade or business as defined, and the corporation must have been valued at no more than $50 million at the time the stock was issued. 

Selected expired provisions retroactively reinstated for 2015 and extended (but not made permanent) include:

1.      50% bonus depreciation expense of the cost of purchasing new machinery, equipment, and other business personal property and certain qualified real estate improvements.  The extension of the bonus depreciation percentage amount is as follows:

a.      50% for property placed in service in 2015 through 2017

b.      40% for property placed in service in 2018

c.      30% for property placed in service in 2019

d.      Expired for property placed in service after 2019

2.      The enhanced first-year depreciation ceiling on new autos and trucks.  Tax law severely limits the amount of depreciation that can be claimed on business vehicles rated at 6,000 pounds of gross vehicle weight or less.  For example, for autos placed in service in 2015, the first year depreciation deduction is only $3,160 assuming the auto was used 100% for business.  The ceiling was enhanced by $8,000 ($11,160 in total) when bonus depreciation was in effect.  Now that 50% bonus depreciation has been reinstated, the first year vehicle depreciation limit is increased as follows:

a.      $8,000 for vehicles placed in service in 2015 through 2017

b.      $6,400 for vehicles placed in service in 2018

c.      $4,800 for vehicles placed in service in 2019

d.      None for vehicles placed in service after 2019

Selected Individual Tax Provisions of the “Protecting Americans from Tax Hikes Act of 2015”

On December 16^th, the Senate Finance Committee and the House Ways and Means Committee agreed on tax legislation extending many tax provisions that had expired at the end of 2014, making some of the provisions permanent.  There does not appear to be any spending cuts associated with the $680 billion in tax cuts, so the federal deficit continues to grow!  Making some provisions permanent brings more certainty to the tax code and will help individuals with their financial and tax planning.

Selected expired provisions retroactively reinstated for 2015 and made permanent include:

1.      Tax-free distributions (not to exceed $100,000) made directly to public charities (but not a donor advised fund) from individual retirement accounts (IRA) by individuals at least age 70 ½.  The charitable IRA distribution is not included in gross income and the donation is not deducted as an itemized charitable deduction.  Tax savings come from having a lower adjusted gross income (AGI).  AGI is used frequently to increase tax expense, and having a lower AGI can lower tax.  Another important benefit is that qualified charitable distributions count in satisfying the required minimum distribution for the year.

2.      The enhanced American opportunity tax credit originally scheduled to expire at the end of 2017 is now made permanent.  An annual credit of up to $2,500 is permitted for the cost of four years of post-secondary education.  It is phased out as AGI exceeds certain indexed thresholds.

3.      The itemized deduction of State and local general sales tax is permanently reinstated.  Taxpayers can deduct the greater of sales or income taxes.  Without this provision, residents of the seven states without income tax would have no deduction.  The provision can also benefit those with low state income tax.

4.      Although not an “extender,” several improvements are made to Section 529 educational savings plans beginning in 2015.  First, qualified expenses now include computers and peripheral equipment, software, and internet access.  Second, multiple 529 plans for the same beneficiary no longer need to be aggregated to determine the taxable portion of non-qualified distributions.  Third, where a distribution was used to pay qualified higher education expenses and any amount is refunded from the educational institution (thus rendering that portion of the distribution nonqualified), the refund can be rolled back in to the 529 plan account within 60 days of receipt to avoid tax and penalty.

5.      Other permanent extensions include the enhanced child tax credit, the enhanced earned income credit, and the “above-the-line” deduction for certain expenses of elementary and secondary school teachers. 

Selected expired provisions retroactively reinstated for 2015 and extended (but not made permanent) include:

1.      The deduction of home private mortgage insurance (PMI) premiums as qualified residence interest expense is reinstated through 2016.  This deduction is ratably phased out as AGI exceeds certain thresholds.  PMI is required of home buyers having less than a 20% down payment.

2.      The “above-the-line” deduction of up to $4,000 of qualified tuition and related expenses for higher education is reinstated through 2016.  The amount of the deduction is reduced as AGI exceeds certain thresholds.  Most often the American opportunity credit will be claimed on these expenses, but there are occasions when this deduction is better.

Blog, Recent Taxpayer-Friendly Changes to the Tangible Property Regulations

Last year taxpayers dealt for the first time with massive IRS regulations governing the acquisition of tangible property and capitalizing improvements.  The Regulations contain lengthy and specific rules regarding when to expense and when to capitalize the purchase, repair, and maintenance of property.  Certain safe-harbors and tax elections were provided for administrative ease.

Two recent changes have brought new taxpayer-friendly simplifications.  In IRS Notice 2015-82, the IRS announced the increase from $500 to $2,500 in the “de minimis safe harbor” limit effective for tax years beginning after 2015.  However, the Notice states that the IRS won’t audit expensed amounts in earlier years if at or under the new $2,500 limit.  That statements appears to open the door for taxpayers to change their 2015 expensing policy from $500 to $2,500.  The safe harbor must be elected each taxable year.  The safe harbor allows taxpayers to simply expense the purchase of small-cost assets rather than depreciating them.  In order to use the safe harbor, the taxpayer’s accounting policy statement must state that assets costing no more than the limit be expensed.  The policy must actually be followed, meaning that the financial books and records must show the purchased item as an expense rather than as an asset.  The Regulations do not require the accounting policy to be in writing, but that is a best practice.  There is a higher $5,000 limit available to companies that have financial audits, termed “applicable financial statements” (AFS).  For the $5,000 safe harbor for taxpayers having an AFS, the accounting policy is required to be in writing by the beginning of the tax year.

Revenue Procedure 2015-56 deals with the second recent change, permitting the majority of costs associated with the remodeling or refreshing of retail stores to be deductible under a new safe harbor, effective for tax years beginning on or after January 1, 2014.  Retail stores and restaurants regularly change and improve many aspects of their property to keep up with the competition and with the changing tastes of customers.  Determining which expenditure should be capitalized or expensed is a complicated exercise under the tangible property regulations.  To simplify these complexities, the IRS has created a new safe harbor, but only for “qualified taxpayers.”  Under the safe harbor, a “qualified taxpayer” may deduct 75% of “qualified costs” as business expenses with the other 25% capitalized and depreciated as an improvement to a building.  The 25% portion is termed the “capital expenditure portion” and is itself not eligible for a future partial disposition election.  A qualified taxpayer must have an AFS (audited financial statement) and either (1) sell merchandise to customers at retail (but not car dealers, gas stations, manufactured home dealers, and nonstore retailers), or (2) prepare and sell meals, snacks, or beverages to customers for immediate consumption (but not hotels, civic or social organizations, amusement parks, theaters, casinos, country clubs, and special food services such as caterers and mobile food services), or (3) own or lease a qualified building to a taxpayer qualifying under (1) or (2).  Adopting this safe harbor is an “automatic” change of accounting method (and not an election) requiring the filing of Form 3115.  The method change requires the calculation of a so-called IRC §481(a) adjustment.  If a prior “partial disposition” election was made, a coordinating rule must be followed, revoking the election.  Once adopted, the safe harbor method must be followed for all remodel-refresh projects.  While this safe harbor simplifies the tax accounting of remodel and refresh expenditures, adopting the safe harbor is a complicated process and the Revenue Procedure must be consulted for all of the detailed requirements.

Selected Tax Provisions in the Fixing America’s Surface Transportation (FAST) Act

The FAST Act (P.L. 114-94) was signed into law on December 4, 2015.  The Act funds certain Federal surface transportation programs through 2020.  Several tax provisions were included in the Act.

Revocation or Denial of Passports to Certain Delinquent Taxpayers

The IRS will provide the State Department information on taxpayers having “seriously delinquent tax debt” exceeding $50,000 (as indexed for inflation after 2016).  The State Department would then have grounds to deny, revoke, or limit the use of a U.S. passport effective January 1, 2016.  A seriously delinquent tax debt arises when a notice of lien (a security interest in property) or levy (a seizure of property) has been filed by the IRS.  Exceptions are:

·        The taxpayer is making timely payments under an installment agreement or under an offer in compromise.

·        Collection efforts have been suspended for a due process hearing or for innocent spouse relief.

Use of Private Debt Collectors

Despite past protestations from the National Taxpayer Advocate, Congress has now mandated that the IRS hire private debt collectors for “inactive tax receivables.”  The term “tax receivable” means any outstanding assessment which the IRS considers potentially collectible.  The term “inactive tax receivable” means any tax receivable if:

·        At any time after assessment, the IRS removes such receivable from the active inventory for lack of resources or inability to locate the taxpayer,

·        More than 1/3 of the period of the applicable statute of limitation has lapsed and such receivable has not been assigned for collection to any employee of the IRS, or

·        In the case of a receivable which has been assigned for collection, more than 365 days have passed without interaction with the taxpayer or a third party for purposes of furthering the collection of such receivable.

Repeal of Lengthened Automatic Filing Extension Time Period for Forms 5500

One of the provisions enacted on July 31, 2015 in the temporary highway funding bill was to lengthen the automatic extension of time to file Form 5500 for retirement and benefit plans from 2 ½ months to 3 ½ months for tax years beginning after 2015.  The FAST Act now restores the prior 2 ½ month extension period by repealing the 3 ½ month period.

Major Changes Coming for Utah Limited Liability Companies on January 1, 2016

 Significant changes are looming that could impact the legal operation of your Utah LLC.  The impact will depend in part upon on whether your existing LLC operating agreement addresses the default provisions in the new law.  When the Utah Revised Uniform Limited Liability Company Act (“New Act”) was enacted, it was initially only applicable to LLCs established on or after January 1, 2014, or to pre-existing Utah LLCs that elected to apply its provisions.  Now the New Act applies to all pre-existing Utah LLCs as of January 1, 2016.  The New Act contains several default rules that, unless otherwise altered by an operating agreement, will apply to your LLC.  These should be discussed with your attorney before the end of the year.

Listed below are several of the default rules (but not an exhaustive list) for your company to evaluate and consider, including matters relating to LLC duration and formation, establishment of an oral operating agreement, rules for voting and distributions, member-creditor protection, fiduciary duties of loyalty, care and good faith, accuracy of public record, rights of members and managers, and statutory apparent authority. 

·       LLCs may now exist for a perpetual duration with the filing of a Certificate of Organization.  Existing LLCs will need to file an amendment to its Articles of Organization along with the Certificate of Organization.  Under the New Act, company managers are now permitted to remain unnamed in the Certificate of Organization.

·       The legal recognition of an operating agreement may now be established orally or based on the conduct or habits of the members and managers of the company.  As such, members must be aware of implied agreements based on casual conversations or actions, and limit agreements and amendments to those expressed in writing.

·       The default rule for voting states that each member now receives one vote without regard to member’s LLC interest or capital contributions unless the operating agreement specifies otherwise.  Similarly, non-liquidating distributions also default to a per capita arrangement if not addressed in the operating agreement.

·       Upon liquidation, member-creditors are no longer subordinate to non-member creditors but will be on equal standing with third-party lenders.  However, if the language of the operating agreement favors third-party creditors, this provision will supersede the default rules of the New Act and may be required by your third-party lender.

·       The fiduciary duties of members and managers has moved beyond the limitation of “gross negligence” “willful misconduct” or a breach of a higher standard of care that was set forth in the LLC’s operating agreement.  The New Act has expanded these obligations to include the duty of loyalty, duty of care, and the contractual obligation of good faith and fair dealing.  These obligations can present pitfalls.  For example, the duty of loyalty could be interpreted as imposing a non-competition obligation on members or managers.  The new rules allow for the operating agreement to specify and tailor the standards to agree with the LLCs business purpose as long as these additional statutory duties are not eliminated.

·       LLCs are now liable for inaccurate information in the public record.  The company may also be held responsible for damages incurred by persons who suffer loss as a result of relying on the information provided by the documents on record.

·       By statute LLCs are responsible under the duty of candor to provide information to all its members or managers concerning matters of consent or approval when presented to the company.  The LLC must supply all material facts and substance, such as financial statements used in mergers or other business combination transactions, to all members.

·       To provide LLCs with greater flexibility the New Act eliminates the requirement of statutory apparent authority by position (i.e. Manager Managed vs. Member Managed). The management authority is now determined by the operating agreement or by a Statement of Authority that is recorded with the County Recorder.

In closing, the default rules of the New Act will come into effect and impact all LLCs as of January 1, 2016.  Particularly for LLCs formed prior to 2014, evaluate how closely these rules fall in line with the company’s goals and determine whether the enacted changes will result in any potential unintended consequences for your members.  We suggest that you contact your attorney to review your existing operating agreement for areas for amendment or to create a written operating agreement if one is not currently in place.  As an accounting firm we are unable to provide such legal advice.

Saving for Higher Education Expenses with the UESP

The Utah Educational Savings Plan (UESP) is one of the top rated Section 529 savings plans in the country.  Although contributions (which are required to be in the form of cash) are not deductible, account earnings are exempt from income tax when used to pay for qualified higher education expenses of the account beneficiary at any eligible college, technical school, or university that participates in federal financial aid programs for students.  Qualified expenses include tuition and fees, books, supplies, and required equipment.  “Reasonable” room-and-board expenses are permitted for students enrolled at least half-time.  Account earnings spent on non-qualifying expenses are subject to income tax and a 10% penalty. 

Qualifying expenses are reduced by tax-free educational assistance received, and also by expenses taken into account in determining the amount of the American Opportunity tax credit or the Lifetime Learning tax credit.  In many instances where the student beneficiary is reporting the distribution from the 529 plan, it makes more sense to pay the tax and penalty on the distributed account earnings in order to allow all of the expenses to be considered for the tax credits, some of which are refundable!  It is important to prepare the tax return both ways (with the 529 plan exclusion and again without the exclusion but with the credits) in order to see the best tax outcome. 

In addition to the income exclusion, for Utah residents, a tax credit of 5% on the first $1,900 contributed for a beneficiary is permitted for a single filer, and 5% on the first $3,800 for joint filers.  Multiple credits can be claimed for multiple beneficiaries.  However, the beneficiary must have been age 18 or under when the account was first opened to qualify for the credit, and once qualified, the credit will continue to be available for contributions after age 18.  These dollar amounts are for 2015 and future amounts are indexed for inflation.  Previously claimed Utah credits may be required to be recaptured if funds are spent on non-qualifying expenses. 

Section 529 plans are the only type of account where the donor can act as the account owner and maintain control over the funds and still have the gift excluded from the donor’s taxable estate.  The donor can even take the money back, although the earnings would be taxed and subject to penalty.  The annual exclusion from gift tax is $14,000 for 2015 and 2016.  A tax election permits the donor to make up to 5-years’ worth of gifts to a Section 529 plan account in a single tax year.  Therefore, a donor could quickly build up college savings for a beneficiary by contributing $70,000 at once.  If married, the spouse could also contribute $70,000 to the same account.  The election treats the lump-sum gift as a series of five equal gifts over five calendar years.  A gift tax return, Form 709, must be filed to make the election.  Gift tax returns for the four subsequent years are not necessary, unless more gifts are made to that beneficiary.  In such a case, the additional gifts are taxable and will consume a portion of the donor’s lifetime exemption from gift and estate tax. 

Section 529 plan accounts can only change their investment selection twice in a 12-month period.  The UESP provides many investment selections, including a self-designed age-based allocation.  Several accounts can be created for the same beneficiary if you need more investment flexibility.  In 2015, the maximum total balance permitted for any one beneficiary is $416,000. 

Recent planning innovations have promoted using 529 savings plans to accomplish major gift and estate tax planning objectives, where 529 plans might be considered in place of split-interest trust and charitable giving vehicles.  A subsequent blog post will introduce some of these ideas.

Selected 2016 Inflation-Indexed Figures

Many contribution and deduction amounts in the tax law are indexed for inflation.  Many also have statutory adjustments.  While there remains uncertainty about whether Congress will enact the “extenders” legislation before the end of 2015, some important 2016 inflation-adjusted figures have been released and are as follows: 

1.      The top 39.6% ordinary income and 20% long-term capital gain tax rates apply when taxable income exceeds $466,950 for joint filers (up from $464,850 in 2015) and $415,050 for single filers (up from $413,200 in 2015).  For trusts and estates, the top rates apply when taxable income exceeds $12,400 (up from $12,300 in 2015).

2.      Itemized deductions and personal exemptions begin to “phase-out” once adjusted gross income exceeds $311,300 for joint filers (up from $309,900 in 2015) and $259,400 for single filers (up from $258,250 in 2015).  These phase-outs do not apply to trusts and estates.

3.      The personal exemption is $4,050 (up from $4,000 in 2015).

4.      The contribution amount for traditional and Roth IRAs remains $5,500 (the same as in 2015).  For those who are age 50 and older, the additional “catch-up” contribution is $1,000 and is not indexed for inflation.

5.      The modified adjusted gross income phase-out range for contributions to Roth IRAs is from $184,000 to $194,000 for joint filers (up from between $183,000 and $193,000 in 2015); and from $117,000 to $132,000 for single filers (up from $116,000 and $131,000 in 2015).

6.      The contribution amount for traditional and Roth 401(k) accounts remains $18,000 (the same as in 2015).  For those who are age 50 and older, the additional “catch-up” contribution remains $6,000 (the same as in 2015).

7.      The limit on the annual additions to a participant's defined contribution account remains $53,000 (the same as in 2015).

8.      The annual exclusion from gift tax remains $14,000 per donee (the same as in 2015).

9.      The lifetime exemption from estate, gift, and generation-skipping transfer taxes increases to $5,450,000 (up from $5,430,000 in 2015).

10.   The Social Security tax wage base remains $118,500 (the same as in 2015).

11.   The maximum annual contribution to a health savings account remains $3,350 (the same as in 2015) for an individual-coverage-only health plan, and $6,750 (up from $6,650 in 2015) for a family-coverage health plan.  For employees age 55 and older, the additional HSA "catch-up" contribution is $1,000 and is not indexed for inflation.

Tips for National Estate Planning Awareness Week

The U.S. Congress has designated the third week in October (this year, the 19^th through the 25^th) as National Estate Planning Awareness Week.  Commentators estimate that 70% of Americans do not have an estate plan.  Without your own estate plan, your property will pass according to the laws of the state in which you reside, and the state’s plan may not be how you would like your property to pass.  Below are a few estate planning tips for you to consider. 

Estate planning is much more than planning to reduce estate taxes.  With high exemptions from estate tax (currently $5,430,000), only a very small percentage of people are subject to the tax.  So, for the vast majority of people, estate planning really focuses on the most important issues to families:  providing for how your property passes to your heirs, who your heirs are, what they will receive, and when they will receive it.  You know the strengths and weaknesses of your heirs, and the responsibility is yours to make a plan so that their inheritance is a blessing to their lives rather than something that could be squandered or otherwise harmful.  Estate planning also involves providing for your own personal care in the event of disability or incompetency.  It is important to use an attorney who specializes in estate planning and who is familiar with the laws of the state in which you reside.  Some important tools to consider as part of your estate plan include the following: 

·        Will.  A will is used to name the personal representative of your estate, name guardians of minor children, and declare how and to whom your assets are to pass.

·        Living Trust.  Not everyone needs a trust, but if you have substantial assets, a trust can be useful.  When a living trust is used, the Will typically “pours over” your assets to the trust where your estate plan is implemented.  The word “living” means that the trust is established while you are alive.  A trust can also be set up by your will and in that case, it is called a “testamentary” trust.  A trust avoids probate, can keep your estate plans private from public inspection, names trustees and successors who are to manage your properties in your best interest and in the best interest of your trust beneficiaries.  A trust may be designed to hold property for the benefit of heirs who would benefit from such oversight and management rather than having the property pass outright.  A trust can protect your assets that pass to your heirs from loss due to divorce and lawsuits.  A trust may also provide for the management of your property if you become incapacitated, or simply choose to have someone else take on the management role.

·        Power of Attorney (POA).  A POA enables a trusted person to act in your stead in managing and directing the use of your property.  A POA is very useful in the event of your incapacity such as when you are ill or suffer an accident.  A POA can be very broad or very narrow in the scope of powers granted to the agent.  A POA can “spring” into effect when you are incapacitated, or it can have current effect.

·        Health Care Directives, HIPAA Disclosure, and Health Care Power of Attorney.  These documents will guide your agent and medical providers in observing your wishes for end-of-life medical care.  These are important documents and will require your careful consideration and clear instructions. 

For those subject to the estate tax, some basic estate tax reduction strategies that are sometimes overlooked include the following: 

·        Annual Gifting.  Currently $14,000 can be gifted to another person each calendar year without gift tax.  This limit is known as the annual exclusion.  The exclusion is a “use it or lose it” tax benefit.  Unused exclusions do not carryover to the next year.  A married couple can give up to $28,000 annually to any one person without gift tax.  If the gift exceeds the annual exclusion, the excess will consume and reduce the lifetime exemption from estate tax, which is also available for gift tax.  Once the estate/gift exemption is used up, then a 40% gift tax applies to excess gifts.

·        Directly Pay Medical Bills or School Tuition.  Directly paying medical providers and school tuition for expenses incurred by your loved ones do not count against the annual gift exclusion.  In fact, there is no limit on the amount of such expenses that you can pay and avoid taxable gifts.

·        Establish an Irrevocable Life Insurance Trust (ILIT).  If an ILIT applies for and obtains life insurance on your life, then when you die, the death benefits will not be subject to estate tax.  If you are the owner of your own life insurance policy and if your estate is large enough to be subject to estate tax, then the U.S. government is a 40% beneficiary of your death benefits!  There are ways to move your current policies to an ILIT, but in some circumstances, there will be a three-year period that you must outlive in order to exempt the death benefits from estate tax.

·        Make a Substantial Gift of Appreciating Property.  Successful entrepreneurs may start businesses that will be worth a lot of money in the future.  Giving a portion of the ownership to loved ones (e.g. in trust for their benefit) while the value is low will enable the appreciation to occur outside of your estate and it will avoid future gift or estate tax.

·        Name Charities as Beneficiaries of Your Traditional IRA.  If you want a portion of your estate to pass to charity, and if you also have a traditional IRA, consider naming the charity as the beneficiary of your IRA.  Traditional IRA distributions are subject to ordinary income tax when received.  Such tax also applies to distributions received by IRA beneficiaries.  Therefore, there is a double tax that applies to the IRA:  a 40% estate tax on the value of the IRA and ordinary income tax on distributions of up to 44.6%, counting top Federal and Utah income tax rates.  There is a special income tax deduction for a portion of the Federal estate tax attributable to the distribution received, but the deduction doesn’t perfectly eliminate the double tax.  A charity is not subject to income tax on IRA distributions.  There is also a deduction for estate tax purposes for assets left to charity.  Therefore, naming a charity as a beneficiary of your traditional IRA is very tax efficient as opposed to using other assets to fund your charitable bequest. 

Estate planning requires careful coordination with how you own your assets and whether beneficiaries have been named on financial accounts.  Form of ownership and beneficiary designations override the provisions in your will and trust.  For example, if you own a mutual fund as joint tenants with your child, at your death your child will obtain complete ownership of the mutual fund and it will not pass according to the terms of your will or trust.  As part of your estate planning you should carefully make a list of your assets, their current values and tax basis, form of ownership, and any named beneficiaries.  With such information you will become aware of any necessary changes required to be made in order to follow your intended estate plan.