Selected Tax Provisions Expiring at December 31, 2011

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

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

IRS Announces New Voluntary Worker Classification Settlement Program

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

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

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

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

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

Medicare Open Enrollment for 2012 Approaching

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

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

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

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

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

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

Extensions Granted for Certain 2010 Estates

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

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

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

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

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

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

IRS Tips for Recently Married Taxpayers

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

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

Budget Super Committee Introduces Tax Uncertainties

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

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

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

Withholding by Government Entities

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

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

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

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