New Utah Law Regarding Domicile Starts in 2012

Utah imposes an income tax on all of the income of its residents, and upon Utah-sourced income of non-residents.  Intangible income such as interest, dividends, and capital gains on the sale of stock are taxed in the state of residency.  A resident is a person who is either domiciled in Utah or is a statutory resident because the person maintains a place of abode in Utah and has spent more than 182 days in Utah during the calendar year.  Domicile means the location of your permanent home, where you intend to return after being away.  A domicile is not changed to another state unless three conditions are met:  1) you have a specific intention to abandon your current domicile, 2) you establish an actual physical presence in the new domicile, and 3) you intend to remain in the new domicile permanently.  When a person changes their domicile, they will be a part-year Utah resident through the date of the move out of state.

Individuals who may have a large capital gain from the sale of an intangible, such as shares of stock, may try and avoid Utah tax on the gain by moving their residence to another state that does not impose an income tax, such as Nevada, Wyoming, or Texas.  If they are able to successfully change their residence to such a state before selling their stock, they can save Utah tax of 5% of the gain.  Obviously the gain would need to be very substantial to warrant the financial and personal costs of moving.

Utah has enacted a new law that takes effect on January 1, 2012.  The law sets forth some "bright-line" tests for determining whether an individual has a Utah domicile.  The following is a selected list of factors to avoid if you are claiming to no longer be a Utah resident.

1. You or your spouse are claiming resident tuition as a student attending a public university in Utah,
2. You have a dependent who is claimed on your personal federal income tax return who is enrolled in a public kindergarten, elementary, or secondary school in Utah,
3. You or your spouse claim the 45% primary residence exemption from real estate tax on a home in Utah,
4. You or your spouse are registered to vote in Utah,
5. You or your spouse have a Utah driver's license,
6. You or your spouse have a vehicle registered in Utah,
7. The nature and quality of your living accommodations in Utah are superior to those in the other state, and
8. You or your spouse have claimed to be a Utah resident on an income tax return or on a document filed with or provided to a court or other governmental entity.

Other rules and factors apply.  The new law is found in the Utah Code at 59-10-136.

The Utah Educational Section 529 Savings Plan

The Utah Educational Savings Plan (UESP) is a special college expense savings plan authorized under Section 529 under the Internal Revenue Code.  A parent or a grandparent (for example) can open an account for the benefit of a child or grandchild.  Even though the account owner controls the funds, the contribution to the account is treated as a gift qualifying for the annual $13,000 (in 2011-2012) gift tax exclusion amount.  A special election permits up to five years of gifts to be front-loaded.  For example, if a grandfather contributed $65,000 to the account in 2011, the grandfather could not give any more to that grandchild for the years 2011-2015 without consuming part of the his lifetime exemption from gift and estate tax or incurring some gift tax if the exemption was previously utilized.  If the grandfather died during the five-year time period, the portion of the gift relating to future years would be taxable in his estate.

A Section 529 plan has special income tax benefits.  Income and gains in the account are not taxable.  Account withdrawals are not taxable if used to pay for qualifying higher education expenses, such as tuition, fees, books, room and board.  Withdrawals not used to pay qualifying college expenses are subject to income tax.  The portion of the withdrawal attributable to account earnings is included in the account owner's income tax return and also subject to a 10% penalty.  In addition to following the Federal tax benefits, Utah permits a 5% income tax credit on the first $1,740 (single filer) or $3,480 (joint filer) of contributions for 2011 if the account owner is a Utah resident and provided that the beneficiary was under age 19 when named as the account beneficiary.  The dollar limit is indexed for inflation each year.  The credit can be claimed for more than one qualifying beneficiary.  The credit can be claimed even after the beneficiary turns age 19 or older provided the beneficiary was originally named beneficiary before age 19.

The UESP has been highly rated over its low expenses and investment selection.  More information and enrollment can be made at www.uesp.org.

Tax-Free Gains on Qualified Small Business Stock

A brief time window remains for certain new businesses to be organized as a C corporation for which gain realized on the future sale of stock will be exempt from income tax.  A 100% exclusion applies to Qualified Small Business Stock (QSBS) acquired by noncorporate taxpayers during the period of September 28, 2010 through December 31, 2011.  After 2011 the exclusion drops to 50%.  Also, for QSBS acquired after 2011, an alternative minimum tax preference applies to a portion of the excluded gain.  Furthermore, a 28% Federal capital gain tax rate (instead of the usual 15% maximum rate) applies to unexcluded QSBS capital gains after 2011.  The opportunity to exclude capital gains from income tax also applies to purchases of QSBS from existing corporations that meet the requirement.  Some of the basic requirements are the following:

1. The purchase must be of original issue (after August 10, 1993) stock from the corporation in exchange for money, property contributed to the corporation, or services rendered to the corporation,
2. The corporation must be a domestic C corporation and it may not make the S election,
3. Immediately after the stock is issued, and at all times after August 9, 1993 and before the stock is issued, the corporation's total gross assets are and were $50 million or less, and
4. At least 80% of the value of the corporation's assets were used in the active conduct of one or more qualified businesses.

A qualified business is one that is NOT:

1. A service business in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, consulting, athletics, financial services, or brokerage services,
2. A business whose principal asset is the reputation or skill of one or more employees,
3. A banking, insurance, financing, leasing, investing, or similar business,
4. A farming business,
5. A business whose products are eligible for percentage depletion, or
6. A hotel, motel, restaurant, or similar business.

To be eligible for the gain exclusion, the QSBS must have been held for more than 5 years.  In addition, there is a limitation on how much gain can be excluded.  The limitation is the greater of:

1. A lifetime limit of $10 million of gain from the sale of QSBS in the same corporation ($5 million if married filing separately), or
2. Ten times the taxpayer's total adjusted basis in the QSBS sold.

While the tax benefits of investing in QSBS are significant, so are the rules that must be met to qualify.  If you have the opportunity of investing in or establishing a qualified small business, due diligence must be performed in order to ascertain whether the tax rules have been met before you make the investment.

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).