Congress Passes the 2010 Hiring Incentives to Restore Employment (HIRE) Act

On March 17, 2010, Congress passed a new "jobs bill" that Pres. Obama is expected to quickly sign.  The HIRE Act provides a "tax holiday" for employers who hire "qualified individuals."  The 6.2% employer portion of the Social Security tax is waived on wages paid after the date of enactment through the end of 2010 to qualifying new hires.  No waiver is available for the employer's 1.45% share of the Medicare tax.  A qualified individual must start work after February 3, 2010 and before January 1, 2011.  Such individual must certify that he or she has not been employed for more than 40 hours during the 60-day period ending on the date of hire.  Many special rules apply, such as the new hire cannot displace a current employee unless the current employee leaves voluntarily or is fired for cause.  In addition to the payroll tax savings, the employer will receive up to $1,000 of tax credits for each qualifying new hire who is employed for at least 52 consecutive weeks.  Again, special rules apply.

The HIRE Act extends the 2009 enhanced levels of business equipment expensing under Code Section 179.  The expensing limit is $250,000, reduced for purchases over $800,000, for purchases made in tax years beginning in 2010.  Previously, those limits would have been $125,000 and $500,000.  Note that the expensing limit is based upon purchases made during "tax years" and not simply calendar year 2010.  The HIRE Act did not extend the 50% bonus depreciation for new equipment purchases that expired on December 31, 2009.

Income from the Cancellation of Indebtedness

Recent tough economic times have led some lenders and borrowers to work out debt modifications, including the cancellation or forgiveness of some or all of the debt.  The amount of the cancelled debt generally must be reported as income on your tax return.  If a financial institution forgives the debt, it is required to issue Form 1099-C, reporting the amount of the forgiveness to the IRS.  There are many specific provisions that excuse the debtor from having to pay tax on the forgiven debt.  These include the following:

• Discharge of a private debt from a relative or friend that is intended as a gift,
• Discharge of student loans of doctors, nurses and teachers who agree to serve in rural or low income areas and meet certain conditions,
• Discharge of debt that, if paid, would have resulted in a tax deduction (e.g. accrued mortgage interest expense),
• Reduction in price for the purchase of property,
• Discharge of debt through bankruptcy,
• Discharge of debt of an insolvent taxpayer,
• Discharge of qualified farm debt,
• Discharge of qualified real property business debt, and
• Discharge of qualified principal residence debt.

There are many complicated rules and time limits associated with these exceptions.  Most of these exceptions must be reported to the IRS on Form 982 and result in the reduction of certain tax attributes, such as the tax basis of property or the carryover of tax losses.

Is a Roth IRA Conversion a Good Idea?

This article assumes that you are familiar with the features of a Roth IRA and the opportunity to convert your traditional IRA to a Roth IRA. Refer to my November 11, 2009 post for some background information. This post reviews a few “rules of thumb” to determine whether you might be a good candidate for a conversion. There is no mathematical benefit to a conversion if your income tax rate in retirement is the same as the tax rate for the year of conversion and you pay the conversion tax with IRA funds. Some other factor is needed for the conversion to be favorable, such as:

• You have non-IRA funds that can be used to pay the conversion tax.
• Your average tax rate will be higher in the future (when you retire and draw upon IRA funds) than your marginal tax rate at conversion.
• You have a net operating loss carryover (but not a capital loss carryover) or an unused charitable contribution that could offset some of the conversion income.

In addition, if you have one of the following characteristics, you may find the Roth conversion useful:

• You don’t need the IRA to fund retirement expenses and can leave it to your heirs.
• Your proportion of nondeductible IRA tax basis to the total value of all your IRAs is over 50%.
• Your IRA assets are temporarily depressed in value or are expected to greatly increase in value in the future.

However, a Roth IRA conversion is not a good idea for most middle- and upper-middle-income people. Such people need to rely on their IRA to fund retirement. The marginal tax paid when converting the traditional IRA will almost always be higher than the average tax paid in retirement when taking IRA distributions. Even if tax rates increase in the future, those increases will mostly affect the upper tax brackets applicable to very high income earners. Not many taxpayers in the 28% marginal bracket today will be pay an average 28% rate in retirement because the income tax brackets are indexed for inflation, and the average of lower brackets will always be less than the highest rate bracket to which you are subject. Therefore, be very careful of making a Roth IRA conversions if:

• You are not consistently in the top income tax bracket, and if not,
• You will pay conversion tax at a marginal tax rate above 15%.

Update on 2010 Charitable Contributions

Congress has passed the Haiti Charitable Deduction Bill (H.R. 4462) that permits taxpayers to make an election to deduct cash charitable contributions on their 2009 income tax return for Haiti relief donations made after January 11, 2010 and before March 1, 2010.  Normally cash donations are deductible in the tax year made.  Be sure to let your tax preparer know if you made a donation and would like to make the election.  You will need to keep track of these donations so that if the election is made, the deduction is not again claimed on your 2010 income tax return.  The election can make sense if your marginal 2009 income tax rate will be equal to or greater than your expected 2010 marginal income tax bracket.

Many taxpayers used the provision allowing individuals aged 70 1/2 and older to donate up to $100,000 from their individual retirement accounts (IRAs) and Roth IRAs to public charities without having to count the distributions as taxable income.  This provision expired on December 31, 2009.  The U.S. House passed a tax extenders bill on December 9, 2009 to extend this provision through 2010.  However, the U.S. Senate has not yet taken up a tax extenders bill.  Therefore, this popular provision is not currently available, but may be restored if the Senate acts upon it later this year.

Required Minimum Distributions Restart in 2010

Employer-sponsored defined contribution retirement plans (profit sharing plans, 401(k)s, etc.) and IRAs are subject to so-called, required minimum distribution rules.  The rules generally apply upon attainment of age 70 1/2 or after the death of the retirement account owner.  A 50% penalty of the RMD amount applies to failures to distribute the required amount.  The rules and penalty are designed to force out retirement savings so that they will be subject to income tax during the owner's retirement years and to prevent the use of retirement accounts solely as an inheritance vehicle.  The government enacted a one-year waiver of these rules for the year 2009 in response to the 2008 stock market crash.

Now that the waiver is over, what are the general implications for 2010?

• Those who attained age 70 1/2 prior to 2009:  use the account value as of December 31, 2009, the Uniform Lifetime Table factor for their attained age in 2010, and make the distribution no later than December 31, 2010.
• Those who attained age 70 1/2 in the year 2009:  use the account value as of December 31, 2009, the Uniform Lifetime Table factor for their attained age in 2010, and make the distribution no later than December 31, 2010.  The special rule that allows a deferral of the first RMD to April 1st of the calendar year following the year age 70 1/2 is reached does not apply.
• Those who attain age 70 1/2 in 2010:  regular RMD rules apply (including deferral of the first RMD to April 1, 2011) as the waiver has no effect.
• Beneficiaries using the five-year payout method:  the year 2009 is not counted as one of the five years.
• Beneficiaries using the lifetime payout method:  use the account value as of December 31, 2009 and apply the life expectancy factor from Single Life Table using the normal rules.

RMD rules can be quite complicated to apply and the one-year waiver for 2009 introduces some uncertainty into the process of restarting the RMDs in 2010.

Congress Fails to Act, Allows 2010 Estate Tax Repeal

Contrary to most expectations, Congress failed to act by the end of 2009 to extend the estate tax at least to 2010, preventing the long-scheduled repeal of the estate tax.  The U.S. House of Representatives had passed an extension of the estate tax on December 3rd, but the U.S. Senate failed to consider a bill because of its pre-occupation on Health Insurance Reform.  Current expectations are that the Senate will consider an estate tax bill early in 2010 and extend the tax retroactively to the beginning of 2010.  However, there is no guarantee that this will happen as partisan politics could likely cause this issue to remain unresolved.  While the Congress has successfully hiked tax rates retroactively in the past, some advisors wonder if retroactively enacting a tax that no longer exists is constitutional.  Continued failure to act in 2010 will allow the "sunset" of the estate tax repeal in 2011 when the estate tax returns with a much lower exemption amount and a much higher tax rate.

Those who have estate tax planning documents in place face many problems and uncertainties.  What happens when assets are to be passed to trusts and others based upon formula clauses that reference tax provisions that no longer exist?  For example, many plans fund a credit shelter trust with an amount equal to the unused applicable exemption amount.  What does the trust receive if a person dies in 2010 when there is no estate tax?  In addition, the repeal of the estate tax brings along the dreaded carryover basis rules in which the income tax basis of inherited assets are no longer "stepped-up" (usually) to fair market value.  What if the estate tax is retroactively reinstated and it is challenged in court?  Many years of uncertainty could go by before we know whether the reinstatement was constitutional.  Congress's failure to resolve this important issue before the end of 2009 is irresponsible and shows a lack of true leadership.  The cost and pain of uncertainty inflicted upon families dealing with death and family inheritances is unconscionable.

Utah Governor's Fiscal 2011 Budget Recommendations

On December 11, 2009, Governor Gary R. Herbert released his recommendations for Utah's 2010-2011 fiscal year budget.  Although the Governor did not propose any new taxes, his recommendations include two proposals to modify current tax law in two respects.  First, he proposes that individual's begin making quarterly estimated income tax payments beginning in tax year 2011.  Utah is currently one of only three states having income tax that does not require quarterly estimated payments (the other two being Idaho and Tennessee).  This change would accelerate $125 million of tax collections into the fiscal 2011 budget year.

Second, the Governor proposes repealing the sales tax vendor discount beginning in July 2010.  Businesses having sales tax over $50,000 in the previous year must remit sales taxes on a monthly basis.  The state pays these vendors 1.31% of the combined collected sales tax as a means to offset the financial burden of monthly filing versus annual filing.  Technology has brought down the cost of monthly filings and so the vendor discount is no longer deemed necessary.  This change would result in annual savings to the State of $20 million, beginning with the fiscal 2011 budget year.