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.