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  The withholding provision was originally enacted as part of the Tax Increase Prevention and Reconciliation Act of 2005, to be effective in 2011.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.