Paul Jones | Utah Attorney

Tax Law Developments in the First Quarter of 2012

paul — Tue, 24 Apr 2012 15:33:05 +0000

Here are some of the more important tax developments that have come out during the first three months of 2012. Most are documents from the Internal Revenue Service, but some are important cases and legislative changes you might want to be aware of for you or your business.

Payroll Tax Cut Full-Year Extension: On February 22, President Obama signed into law the Middle Class Tax Relief and Job Creation Act of 2012, extending the payroll tax cut for the remainder of 2012. The legislation maintains the FICA payroll tax rate for employees at the 4.2% rate that has been in place since January 2011, rather than the historical rate of 6.2%. Note that unless Congress decides to extend the lower rate again, the 4.2% rate expires December 31, 2012. The extension does not affect the 10.4% SECA rate, as that was already in place through 2012.

Business Automobile Depreciation Limits: In Rev. Proc. 2012-23, the IRS provided inflation-adjusted automobile (including trucks and vans) depreciation deduction limitations and automobile (including trucks and vans) lessee inclusion amounts for 2012, including automobiles, cars and trucks eligible for first-year additional depreciation.

Deduction for Mortgage Interest: In an IRS Chief Counsel Memorandum, CCA 201201017, the IRS advised that any reasonable method, including the exact and simplified methods described in temporary regulations to §163, the method provided in Publication 936, Home Mortgage Interest Deduction, or a reasonable approximation of those methods, may be used until final regulations are issued specifically addressing allocations of interest on part of acquisition and/or home equity indebtedness that exceeds qualified residence interest limitations. In Sophy v. Comr., the U.S. Tax Court held that unmarried taxpayers who owned homes in California as joint tenants may not deduct more than a proportionate share of interest on $1 million of acquisition indebtedness and $100,000 in home equity indebtedness. The Tax Court determined that the debt must be determined per residence rather than per taxpayer. In the case, two unmarried taxpayers owned two homes with mortgages totalling more than $2.2 million. The each attempted to take an interest deduction on $1.1 million of debt per person.

Electronic Filing of Schedules K-1: Certain entities, such as partnerships, are required to annually file a Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., with the IRS and provide a copy to their partners. In Rev. Proc. 2012-17, the IRS set forth procedures under which a partnership (including an electing large partnership, as defined in §775) that furnishes Schedules K-1 (Form 1065) to its partners electronically will be treated as satisfying the requirements of §6031(b). Prior to the issuance of the new revenue procedure, there was no specific guidance as to whether the furnishing of Schedules K-1 electronically met these requirements. Partnerships must receive the partner’s consent before providing the K-1 electronically, rather than on paper.

S Corporation Dividends: In David E. Watson PC v. U.S., the Eighth Circuit Court of Appeals, in an issue of first impression, held that some of the purported dividend payments that an S corporation made to its sole shareholder constituted wages subject to FICA. The court determined that the characterization of funds distributed by an S corporation to its shareholder-employees turns on an analysis of whether the payments were made as compensation for service, not on the intent of the corporation in making the payments. The court explained that while the concept of “reasonable compensation” is generally applied to the realm of income taxes, the concept is equally applicable to FICA tax cases.

Extension of Deadline to Make Portability Election: Section 2010(c) allows the estate of a decedent who is survived by a spouse to make a portability election to permit the surviving spouse to apply the decedent’s unused exclusion to the surviving spouse’s own transfers during life and at death. The portability election may be made only by the estates of decedents dying after December 31, 2010. Section 6075(a) makes the due date for filing an estate tax return nine months after the date of the decedent’s death. Section 6081(a) provides that IRS may grant a reasonable extension of time for filing any return and that, except in the case of taxpayers who are abroad, no such extension may be for more than six months. In Notice 2011-82, the IRS provided procedures to make the portability election. For estates of decedents dying in early 2011 that had missed the due date for filing Form 706 and Form 4768, the IRS granted, for the purpose of make a portability election pursuant to §2010(c)(5)(A), a six-month extension of time for filing Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return. In Notice 2012-21, the IRS stated that the extension applies when the executor of a qualifying estate did not file a Form 4768, Application for Extension of Time To File a Return and/or Pay U.S. Estate (and Generation-Skipping Transfer) Taxes, within nine months after the decedent’s date of death, and therefore the estate did not receive the benefit of the automatic six-month extension. A qualifying estate is an estate: (1) the decedent is survived by a spouse; (2) the decedent’s date of death is after December 31, 2010, and before July 1, 2011; and (3) the fair market value of the decedent’s gross estate does not exceed $5,000,000.

Repeal of Special Corporate Estimated Tax Payment Rules: The Middle Class Tax Relief and Job Creation Act of 2012, enacted Feb. 22, repealed the special estimated tax payment rules for corporations with assets of at least $1 billion (determined as of the end of the preceding taxable year) that would have impacted payments due in July, August or September 2012, 2014, 2015, 2016 and 2019, respectively. The changes were made over numerous pieces of legislation that increased the required payments. Thus, such corporations should determine their estimated tax payment as if the special rules had never been enacted.

Splitter Regulations: On February 14, the IRS published in the Federal Register foreign tax credit regulations concerning who is the taxpayer who may claim the credit when the foreign law differs from the U.S. law in viewing the entity with the right to the income as fiscally transparent (i.e., merely a representative of its owners or members) or as a required member of a combined income regime (such as in the case of a disregarded entity or a consolidated income group). The new rules generally retain the long-standing legal liability standard, but provide that the credit is to follow the income in many of these situations regardless of who pays the tax or has the tax obligation. On the same day, the IRS published temporary regulations under a statutory change in 2010 designed to prevent taxpayers from splitting the foreign income from the creditable foreign taxes so as to claim the latter and defer the former. The rules for these cases generally suspend the credit until the income is recognized for U.S. purposes.

FATCA Proposed Regulations: FATCA, which was part of the 2010 HIRE Act, enacted chapter 4 (§§1471- 1474), which in turn imposes 30% withholding on “withholdable payments” to foreign financial entities (FFIs) and certain nonfinancial foreign entities (NFFEs) unless they report U.S. account owner information to the IRS. Withholdable payments are basically fixed or determinable annual or periodic (FDAP) gains and the gross proceeds of the sale or disposition of FDAP income-producing assets. With the issuance of the proposed regulations on February 8, there is no longer any doubt that the objective of FATCA is information reporting, not withholding — withholding is simply the “incentive” to report.

In general, the proposed regulations, which build on earlier preliminary guidance aim to reduce FATCA’s compliance burden and to provide (through transitional rules) ample time for affected entities to comply with chapter 4. The proposed regulations establish a timetable for implementation (including grandfathered treatment for pre-existing obligations), exempt many classes of entities that would otherwise be subject to FATCA, set out payee/beneficial owner identification and documentation procedures, and provide FFI due diligence procedures. The proposed regulations also signal the IRS’s intention to coordinate chapter 3 (§§1441-1446) and chapter 4 so as to avoid duplicate reporting.

The same day that the proposed regulations were issued, Treasury issued a joint statement with five countries (the UK, France, Italy, Spain, and Germany). The joint statement would introduce a framework that would let banks send information on their U.S. accounts to their own governments, which then would share the information with the IRS. The framework would not provide country-by-country blanket exemptions; rather, it would provide an alternative mode of FATCA compliance by adjusting local (i.e., foreign) law restrictions to allow for the automatic exchange of information between and/or among participating governments. (It’s not yet clear if the framework would be implemented multilaterally or bilaterally.)

Offshore Voluntary Disclosure Initiative: On January 16, the IRS announced that it is reopening its special program to allow taxpayers to disclose their offshore assets to the government for a third time. According to the IRS, the program will be open for an indefinite period until otherwise announced. A few key differences in this program from 2011, include its open-ended structure and a slightly higher top penalty of 27.5%, up from 25%. But the program does retain a feature that allows some smaller taxpayers to be eligible for a 5% penalty or a 12.5% penalty. To participate, taxpayers must file all original and amended tax returns and include payment for back taxes and interest for up to eight years, as well as paying accuracy-related and/or delinquency penalties.

Foreign Financial Accounts Reporting: Beginning in 2012, virtually every U.S. individual (including residents, certain nonresident aliens, among others) who files a federal return for the year and had an interest in an applicable account/asset valued over $50,000 on the last day of the year or $75,000 at any point during the year, must file Form 8938, Statement of Specified Foreign Financial Assets. Reporting thresholds vary based on filing status. The form must be filed annually.

Proposed Withdrawal of 2007 Coordinated Issue Paper on Cost Sharing: On January 19, IRS Transfer Pricing Director Sam Maruca, who has said in the past that coordinated issue papers are not the best way to disseminate guidance to the field, announced the proposed withdrawal of a 2007 coordinated issue paper (CIP) on cost sharing. Maruca said the CIP illustrates the hazards of trying to develop a blueprint for transfer pricing cases. “It has been very risky—indeed, has backfired on us—to think we can issue blanket advice in this area,” he said. Following the release of the paper in September 2007, practitioners complained that it was an attempt to retroactively apply the income method, which was not introduced until 2005, when the IRS issued its proposed cost sharing regulations. The issue paper warned auditors to be skeptical of taxpayer attempts to apply the comparable uncontrolled price and residual profit split methods to cost sharing transactions, saying the “discounted cash flow”—an unspecified method in the 1996 regulations, renamed the income method in the proposed regulations—likely was more appropriate.

Merger of the IRS’s Advance Pricing Agreement and Competent Authority Functions. Maruca said the new Advance Pricing and Mutual Agreement Program was up and running February 27. The new structure puts an end to the handoff between the APA Program and the U.S. Competent Authority in bilateral cases, which represent the majority of APAs. Under the old structure, the APA Program, working with the taxpayer, developed a negotiating position in a case and submitted it to Competent Authority, which then undertook the negotiations with the foreign authorities. Now, the same individual will be responsible for both developing and negotiating the position. This is the structure employed by most U.S. trading partners.

Final Rules, Sample Language for Health Plan Summary Benefit Disclosures: Under the Public Health Service Act (PHSA) §2715, group health plans and health insurance issuers that offer group or individual health insurance coverage must provide a summary of benefits and coverage (SBC), as well as a uniform glossary of insurance-related and medical terms, to the individuals they cover. The IRS, HHS and EBSA, who all share rule-making authority under PHSA, issued final regulations that change some of the content requirements that were included in the proposed regulations issued in August 2011. Specifically, the IRS eliminated provisions that would have required premiums (or cost of coverage information for self-insured plans) to be included in SBCs. The IRS indicated that premium information may be too complex to be conveyed in an SBC and is not required by statute. The IRS also modified the final regulations to require SBCs to include an internet address where an individual may review the uniform glossary, a contact phone number to obtain a paper copy of the uniform glossary, and a disclosure that paper copies of the uniform glossary are available. The final regulations apply for disclosures to participants and beneficiaries who enroll or re-enroll in group health coverage through an open enrollment period (including re-enrollees and late enrollees) beginning on the first day of the first open enrollment period that begins on or after September 23, 2012. For disclosures to participants and beneficiaries who enroll other than through an open enrollment period (including individuals who are newly eligible for coverage and special enrollees), the final regulations apply beginning on the first day of the first plan year that begins on or after September 23, 2012. For disclosures to plans, and to individuals and dependents in the individual market, the regulations apply to health insurance issuers beginning on September 23, 2012.

Final Rules on ERISA 408(b)(2) Service-Provider Disclosure: Under final rules issued by the Department of Labor’s Employment Benefits Security Administration February 3, covered service providers to ERISA-covered defined benefit and defined contribution plans must provide to plan fiduciaries the information required to: (1) assess reasonableness of the total compensation, both direct and indirect, that a covered service provider receives from the contract; (2) identify potential conflicts of interest; and (3) satisfy reporting and disclosure requirements under Title I of ERISA. “Covered service providers” include ERISA fiduciary service providers, investment advisers registered under federal or state law, brokers, and recordkeepers. The rule only applies to service providers that reasonably expect to earn $1,000 or more in total compensation under a service contract. The rule does not apply to simplified employee pension plans, savings investment match plans for employees of small employers, individual retirement accounts, certain §403(b) annuity contracts and custodial accounts, or employee welfare plans.

If you have any questions about any of the topics discussed here. Click here to contact Paul.

Understanding Key 2012 Tax Changes

paul — Fri, 10 Feb 2012 16:42:23 +0000

While you may be concerned about your 2011 tax return, right now is a good time to start thinking about 2012. Beginning in 2012, new tax provisions have been enacted, some have been extended that were set to expire, while others have disappeared. This post is an outline of the major tax law changes you should be aware of to minimize taxes. Please note that some of the changes below could be altered again by Congress this year.

New for 2012

• 2-Month Extension of Payroll Tax Break: Temporary extension of the 4.2% Social Security payroll tax rate for individuals originally enacted in 2011 and a new “recapture” provision, which applies only to those employees who receive more than $18,350 in wages during the two-month period.

Expiring in 2012

• Phaseouts of itemized deductions and personal exemptions: The overall limitation on itemized deductions for taxpayers with AGIs above a threshold amount does not apply 2012. The phaseout for personal exemptions for higher income taxpayers also does not apply in 2012.

• Education credit: The American Opportunity Credit replaced the Hope Education Credit for 2009 through 2012 only. The benefits of the new credit are: (1) required course materials, such as books qualify; (2) the credit is increased to up to $2,500; (3) income level phasesouts are higher; (4) forty percent of the credit is refundable.

• Lower capital gains rates: The 15% capital gains rate (0% for taxpayers below the 15% tax bracket) is scheduled to increase to 20% in 2013. Qualifying dividends taxed at reduced capital gains rates will be taxed at ordinary income rates beginning in 2013.

• Increased first-year asset expensing: For 2012, the amount eligible for asset expensing is $139,000 (as indexed for inflation). Beginning in 2013, the amount is reduced to $25,000.

• Refundable portion of child tax credit: The earned income formula for the determination of the refundable child credit applies to 15% of the taxpayer’s earned income in excess of $3,000. This allows more earned income to qualify in order to determine how much of the credit is refundable. Beginning in 2013, the amount will be considerably higher.

• Lower income tax rates: Legislation in 2001, reduced the tax rates on ordinary income through 2010. Legislation in 2010 extended the lower rates through 2012. The current rates of 10%, 15%, 25%, 28%, 33%, and 35% could all change beginning in 2013.

• Higher earned income tax credit: The temporary increase in the EITC percentage from 40% to 45% for families with three or more qualifying children ends in 2012. Additionally, the marriage penalty relief, through an increased threshold phaseout amount for married couples filing joint returns, also expires.

• Child tax credit dollar amount: The $1,000 per qualifying child credit amount is set to be reduced to $500 beginning in 2013.

• 50% bonus depreciation: The additional first-year depreciation for 50% of basis of qualified property.

• Estate tax: Increase in estate and gift tax exemption to $5,120,000 (as indexed for inflation).

Expired in 2011

• Nonbusiness energy property credit: A 10% credit (up to $500, less if any credit was taken in a previous year) is available if you make certain energy efficient improvements to your home. Such improvements include high-efficiency heating and air conditioning systems, water heaters, windows (limited to $200), skylights, doors, insulation and roofs. The improvements must be made to an existing principal residence. A manufacturer’s certificate must accompany the qualifying property.

• Increased AMT exemption amounts: For 2011, the AMT exemption amounts were $74,450 for married filing jointly, $37,225 for married filing separately, and $48,450 for singles and heads of household. For 2012, the exemption amounts are significantly lower (unless Congress acts to adjust): $45,000 for married filing jointly, $22,500 for married filing separately, and $33,750 for singles and heads of households.

• Nonrefundable personal credits offsetting AMT: Only through 2011 could nonrefundable personal credits offset a taxpayer’s alternative minimum tax. However, this rule does not apply to the adoption credit, the child tax credit, the saver’s credit, the residential energy efficient property credit, and the American Opportunity credit, among others.

• Deduction for state sales taxes: The election to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes.

• Educator expense deduction: The $250 above the line deduction for qualifying educators for expenses paid for books and supplies used in the classroom.

• Tuition expenses: The above-the-line deduction for qualified tuition and related expenses.

• D.C. first-time homebuyer credit: Purchases made before January 1, 2012, qualify for the $5,000 D.C. first-time homebuyer credit.

• Charitable contributions from IRA accounts: The ability to distribute up to $100,000 tax free to charity from an IRA maintained for an individual whose has reached age 70¹/₂.

• Research credit: The tax credit for research and experimentation expenses.

• 100% bonus depreciation: The additional first-year depreciation for 100% of basis of qualified property.

• First-time homebuyer credit: First-time homebuyers (including long-term residents) who are certain military personnel on official extended duty outside the U.S. are eligible for the tax credit if the purchase contract is entered into before May 1, 2011, and closing takes place before July 1, 2011.

While there are other minor changes that have taken place from 2011 to 2012, the above list represents tax changes that most likely will impact your 2012 taxes. You also should be aware that Congress is in the middle of deliberations that could lead to the extension of some of the above-mentioned expired or expiring tax provisions.

Click here to contact Paul if you have any concerns about how any of the tax law changes would affect you.

Form 1099-K: How does this affect my business?

paul — Fri, 10 Feb 2012 16:17:05 +0000

The purpose of this post is to discuss the new reporting requirements under Internal Revenue Code (IRC) §6050W for payment settlement entities (PSEs). Generally, PSEs, as entities under contractual obligation to make payment in settlement of payment card (credit card/debit card/gift card/credit account) transactions and third-party network transactions, are responsible for reporting such payments on IRS Form 1099-K, Merchant Card and Third Party Network Payments. The reporting requirements only apply for third-party network transactions when gross payments to any participating payee exceed $20,000, and more than 200 transactions occurred with that payee.

Generally, the PSE submits the instructions to transfer funds to payees’ accounts and thus must file Form 1099-K; however, if you contract with a third party, such as an electronic payment facilitator, to settle reportable transactions and to submit instructions to transfer funds to the participating payee’s account to settle reportable payment transactions, the third party must report by filing Form 1099-K.

Due Dates

For payments made in 2011, Copy A of each Form 1099-K is due to the IRS by February 28, 2012 (April 2 if filed electronically). In subsequent years, the filing dates are February 28 (paper) and March 31 (electronic). The Form 1099-K may be filed electronically after January 4 through the FIRE (Filing Information Returns Electronically) option. There is no fill-in form option.

Copy B of each Form 1099-K is due to the payee by January 31. This copy also may be furnished to the recipient electronically if certain regulatory requirements are satisfied. Please contact me if you wish to discuss this option. You also may furnish this statement on a website, subject to certain restrictions.

Required Information

You must provide your name, address, and federal tax identification number (TIN) in the boxes for filer’s information. You also must provide each payee’s name, address and TIN. You may verify payee TINs on the IRS website. Submissions under these reporting requirements are subject to the IRS Taxpayer Identification Number Matching Program to ensure your Forms 1099-K include the correct TIN. In addition, if your organization has an account number for each payee, it also may be listed on Form 1099-K. If your organization has multiple accounts for a single recipient and more than one Form 1099-K will be filed, you must provide account numbers.

The gross dollar amount for the total reportable merchant card/third party network payment transactions for the calendar year must be reported in Box 1 of Form 1099-K. You must report this amount disregarding any adjustment for credits, cash equivalents, discount amounts, fees, refunds or other amounts. Further, you also must report this amount on a monthly basis in Boxes 5a through 5l.

You must report the four-digit Merchant Category Code (MCC) in Box 2 (third-party settlement organizations need not complete Box 2). You must assign to each payee an MCC that most closely corresponds to the description of the payee’s business. If any recipient has receipts classified under more than one MCC, you may either file separate Forms 1099-K for each MCC, or file a single Form 1099-K reporting total gross receipts under the MCC that corresponds to the largest portion of the total gross receipts.

Penalties

The entity responsible for filing Form 1099-K (i.e., the entity that submits instructions to transfer funds) may contract with a third party to prepare and file Form 1099-K. However, the responsible entity is liable for any applicable penalties (at present, $100 per return that is late-filed or filed with incomplete or incorrect information).

2012 Error Relief

The IRS provided transitional relief, under IRS Notice 2011-89, for inaccurate data submitted on Form 1099-Ks filed in 2012, for payments made in calendar year 2011. The filer must make a good faith effort to file accurately and furnish the required accompanying payee statements. The IRS granted temporary relief from the penalties discussed above.

Please click here to contact Paul for assistance in evaluating the applicability of these reporting requirements to your organization and in creating an effective reporting procedure to ensure compliance.

2011 | 2012 Estate and Gift Tax Planning

paul — Wed, 28 Dec 2011 05:38:15 +0000

This post is a brief discussion of year-end tax planning from an estate and gift tax perspective. In this post, I discuss making gifts to children and grandchildren during 2011 and 2012 without incurring any gift tax. Many of these techniques may also will reduce your overall income tax burden.

Use of Gift Tax Exemptions to Reduce Estate and Gift Tax

Congress reinstated the federal estate tax for 2010 and thereafter, setting the unified federal estate and lifetime gift tax exemption amount at $5 million for 2010 through 2012. For 2012, the amount is inflation-adjusted to $5,120,000. This increased amount is well above the $3.5 million amount effective for 2009. Although the exemption amount and tax rates after 2012 are uncertain, there is no doubt that the estate tax is here to stay. Therefore, a person should consider making sufficient lifetime gifts so that his or her estate will not exceed the exemption amount in effect at death.

Please understand that lifetime gifts are subject to a gift tax imposed at the same rate as the estate tax. This “unified” system is intended to eliminate any tax advantage to making gifts. But certain types of lifetime transfers are not subject to gift tax, and year’s end could be a good time to make such gifts.

Annual Gift Tax Exclusion

The most commonly used method for tax-free giving is the annual gift tax exclusion, which allows a person to give each donee up to $13,000 each year during 2010, 2011 and 2012 without reducing the giver’s estate and lifetime gift tax exclusion amount. A person is not limited as to the number of donees to whom he or she may make such gifts. Thus, if an individual makes $13,000 gifts to 10 donees, he or she may exclude $130,000 from tax. In addition, because spouses may combine their exemptions in a single gift from either spouse, married donors may double the amount of the exclusion to $26,000 per donee.

Because the annual exclusion is applied on a per-donee basis, a donor can leverage the exclusion by making gifts to multiple members of the same family. Thus, a donor could make a $13,000 gift to his son and a $13,000 gift to his daughter, for a total of $26,000 in tax-free gifts. He could double this tax-free amount to $52,000 if his spouse joins in the gifts.

The annual gift tax exclusion applies to gifts of any kind of property, although certain types of property may require an appraisal. Gifts of appreciated property also could result in income tax savings, because the recipient would pay the capital gains tax on any sale. The threat of higher income tax rates in future years makes this an important consideration.

Because a donor may not carry over his or her annual gift tax exclusion amount to the next calendar year, year-end gifting is critical so as to maximize the exclusion’s benefits for each year. If a donor wishes to make a gift exceeding the exclusion amount, he or she can effectively double the exclusion by making one gift in December and the second in January. For example, a married couple could make a tax-free gift of $52,000 to any individual by making a gift of $26,000 in December 2011 and another $26,000 gift in January 2012.

Note that Congress substantially increased the estate and lifetime gift tax exclusion amount, mentioned above, from $1 million in 2010 to $5 million in 2011 and 2012; thus, providing a two-year window for maximizing such giving. Congress also provided that, if a spouse dies in 2011 or 2012 without exhausting his or her estate and lifetime gift tax exclusion amount, the surviving spouse may be able to gift against that amount. This latter provision does not apply to gifts given to grandchildren, i.e., generation-skipping transfers.

Tuition Payment Exclusion

In addition to the annual gift tax exclusion, a person may make tuition payments for any individual without incurring gift tax. Though the amount that may be excluded is not limited, all payments must be made directly to a tax-exempt school at any level, for the purpose of education or training. The exclusion applies only to tuition. Thus, payments for room and board, books, required equipment, or related expenses are not excludible. Because there is no limit on the gift amount, its timing is less important than with the annual exclusion. Nevertheless, if a person has the choice of making either a tuition payment or an annual exclusion gift for a particular beneficiary, it usually is preferable to make the tuition payment, because he or she still could make an annual exclusion gift later in the year.

Congress recently extended the income tax deduction for tuition payments through 2011. To obtain the deduction, the tuition payment must be made to an institution of higher education on behalf of a dependent, and the payor’s adjusted gross income must be below certain limits. Thus, a tuition payment may have some income tax advantages.

Section 529 College Savings Plans

Contributions to a college savings plan established according to Section 529 of the Internal Revenue Code (529 plan) do not qualify for the exclusion for tuition payments, but are covered by the $13,000 annual gift tax exclusion. A contribution to the plan also may entitle the contributor to a state income tax deduction. Thus, a contributor can reduce his or her own income taxes by funding a 529 plan with savings that would have been used for college anyway.

Qualified distributions from a 529 plan may be used for a wide range of educational expenses, including tuition, fees, books, supplies, required equipment, and room and board, but not transportation costs. An added advantage of a gift to a 529 plan is that, generally, the income earned by plan contributions is tax-free, so long as it eventually is used for qualified educational purposes. Also, because the contributor may be the plan’s custodian, he or she can ensure that the beneficiary uses the account for educational purposes.

A special rule allows a contributor to utilize up to five annual gift tax exclusions simultaneously when funding a 529 plan. He or she may fund the plan with up to $65,000 (5 × $13,000) this year, then file an election with the IRS to spread this gift over five years (2011 through 2015) for gift tax purposes. By using five annual exclusions, the entire gift becomes gift-tax-free, although the contributor must wait until 2015 to make another tax-free contribution.

Medical Payment Exclusion

Subject to limitations, a person may exclude from gift taxes all payments he or she makes directly to medical providers on behalf of another individual. These medical expenses must be of the type that would qualify for an income tax deduction. The exclusion for medical payments also includes the payment of medical insurance premiums. Thus, paying a child or grandchild’s insurance premiums is an efficient means of making a tax-free gift that does not consume either the annual gift tax or the estate and lifetime gift tax exclusions. Further, the payor may claim an income tax deduction for a payment made for his or her spouse or dependent.

Gifts in Trust

Despite the tax savings, a person may be uneasy about making outright gifts to children or grandchildren, due to the loss of control over how they use the gift. We can address these concerns by making the gifts in trust, which allows the trust creator to determine when the beneficiaries receive the money and how it is used.

Special requirements exist that ensure that a gift in trust qualifies for the $13,000 annual exclusion. Generally, the trust is drafted to provide the beneficiary with temporary withdrawal rights over the gift (usually for 30 days), such that the gift is considered a present interest rather than one that vests in the future. Although this arrangement presents a risk that the beneficiary could withdraw the gift from the trust, the likelihood of the trust creator terminating any further gifts to the trust is usually sufficient to prevent such withdrawals. If you are interested in making a gift in trust, we can explore this option more thoroughly.

Charitable Gifts

Year end is a good time to review charitable giving to ensure it is accomplished in the most tax-efficient manner. Charitable giving is a form of estate planning because a gift to charity never will be subject to estate or gift tax, and provides the giver with an immediate income tax deduction. If a person wishes to make a large gift before January 1, his or her circumstances must be reviewed to determine the gift’s impact on the giver’s 2011 income tax liability and whether all or a portion of the gift should be deferred to 2012. If the gift is property and requires an appraisal (usually for gifts of property with a value in excess of $5,000, other than publicly traded stock), the process must be started as soon as possible so that the appraisal is available before year end.

In conclusion, I hope that the information in this post is useful in your gift planning for 2011 and 2012. If you wish to take advantage of any of the planning techniques that I have described, please feel free to contact Paul by clicking here.

2011 Year-End Tax Planning for Individuals

paul — Thu, 22 Dec 2011 16:21:13 +0000

As a general reminder, there are several ways in which you can file an income tax return: married filing jointly, head of household, single, and married filing separately. A husband and wife may elect to file one return reporting their combined income, computing the tax liability using the tax tables or rate schedules for “Married Persons Filing Jointly.” If a married couple files separate returns, under certain situations they can amend and file jointly, but they cannot amend a jointly filed return and file separately. A joint return may be filed even though one spouse has neither gross income nor deductions. If one spouse dies during the year, the surviving spouse may file a joint return for the year in which his or her spouse died. Certain married persons who do not elect to file a joint return may be entitled to use the lower head of household tax rates. Generally, in order to qualify as a head of household, you must not be a resident alien, you must satisfy certain marital status requirements, and you must maintain a household for a qualifying child or any other person who is your dependent, if you are entitled to a dependency deduction for the taxable year for such person.

Basic Numbers You Need To Know

Because many tax benefits are tied to or limited by adjusted gross income (AGI)—IRA deductions, for example—a key aspect of tax planning is to estimate both your 2011 and 2012 AGI. Also, when considering whether to accelerate or defer income or deductions, you should be aware of the impact this action may have on your AGI and your ability to maximize itemized deductions that are tied to AGI. Your 2010 tax return and your 2011 pay stubs and other income- and deduction-related materials are a good starting point for estimating your AGI.

Another important number is your “tax bracket,” i.e., the rate at which your last dollar of income is taxed. The tax rates for 2011 are 10%, 15%, 25%, 28%, 31%, and 35%. Although tax brackets are indexed for inflation, if your income increases faster than the inflation adjustment, you may be pushed into a higher bracket. If so, your potential benefit from any tax-saving opportunity is increased (as is the cost of overlooking that opportunity).

IRA, Retirement Savings Rules for 2011

Tax-saving opportunities continue for retirement planning due to the availability of Roth IRAs, changes that make regular IRAs more attractive, and other retirement savings incentives.

Traditional IRAs: Individuals who are not active participants in an employer pension plan may make deductible contributions to an IRA. The annual deductible contribution limit for an IRA for 2011 is $5,000. For 2011, a $1,000 “catch-up” contribution is allowed for taxpayers age 50 or older by the close of the taxable year, making the total limit $6,000 for these individuals. Individuals who are active participants in an employer pension plan also may make deductible contributions to an IRA, but their contributions are limited in amount depending on their AGI. For 2011, the AGI phase-out range for deductibility of IRA contributions is between $56,000 and $66,000 of modified AGI for single persons (including heads of households), and between $90,000 and $110,000 of modified AGI for married filing jointly. Above these ranges, no deduction is allowed.

In addition, an individual will not be considered an “active participant” in an employer plan simply because the individual’s spouse is an active participant for part of a plan year. Thus, you may be able to take the full deduction for an IRA contribution regardless of whether your spouse is covered by a plan at work, subject to a phase-out if your joint modified AGI is $169,000 to $179,000 for 2011. Above this range, no deduction is allowed.

Spousal IRA: If an individual files a joint return and has less compensation than his or her spouse, the IRA contribution is limited to the lesser of $5,000 for 2011 plus age 50 catch-up contributions, or the total compensation of both spouses reduced by the other spouse’s IRA contributions (traditional and Roth).

Roth IRA: This type of IRA permits nondeductible contributions of up to $5,000 a year. Earnings grow tax-free, and distributions are tax-free provided no distributions are made until more than five years after the first contribution and the individual has reached age 59¹/₂. Distributions may be made earlier on account of the individual’s disability or death. The maximum contribution is phased out in 2011 for persons with an AGI above certain amounts: $169,000 to $179,000 for married filing jointly, and $107,000 to $122,000 for single taxpayers (including heads of households); and between $0 and $10,000 for married filing separately who lived with the spouse during the year.

Roth IRA Conversion Rule: Funds in a traditional IRA (including SEPs and SIMPLE IRAs), §401(a) qualified retirement plan, §403(b) tax-sheltered annuity or §457 government plan may be rolled over into a Roth IRA. Such a rollover, however, is treated as a taxable event, and you will pay tax on the amount converted. No penalties will apply if all the requirements for such a transfer are satisfied.

In past years, a taxpayer’s AGI (whether married filing jointly or single) was limited to $100,000 to make such a conversion and the taxpayer must not be a married individual filing a separate return. The AGI limitation does not apply to conversions from a Roth designated account in a §401 or §403(b) plan. For 2011, the $100,000 income limit on Roth IRA conversions does not apply, and taxpayers will be able to make Roth IRA conversions without regard to their AGI. If you convert to a Roth IRA in 2011, the tax on the converted amount will have to be paid in the year of conversion. Also, if you already made a conversion earlier this year, you have the option of undoing the conversion. This is a useful strategy if the investments have gone down in value so that if you were to do the conversion now, your taxes would be lower. This is a complicated calculation and we should meet to determine what your best options are.

In addition, for 2011, if your §401(k) plan, §403(b) plan, or governmental §457(b) plan has a qualified designated Roth contribution program, a distribution to an employee (or a surviving spouse) from such account under the plan that is not a designated Roth account is permitted to be rolled over into a designated Roth account under the plan for the individual.

401(k) Contribution: The §401(k) elective deferral limit is $16,500 for 2011. If your §401(k) plan has been amended to allow for catch-up contributions for 2011 and you will be 50 years old by December 31, 2011, you may contribute an additional $5,500 to your §401(k) account, for a total maximum contribution of $22,000 ($16,500 in regular contributions plus $5,500 in catch-up contributions).

SIMPLE Plan Contribution: The SIMPLE plan deferral limit is $11,500 for 2011. If your SIMPLE plan has been amended to allow for catch-up contributions for 2011 and you will be 50 years old by December 31, 2011, you may contribute an additional $2,500.

Catch-Up Contributions for Other Plans: If you will be 50 years old by December 31, 2011, you may contribute an additional $5,500 to your §403(b) plan, SEP or eligible §457 government plan.

Saver’s Credit: A nonrefundable tax credit is available based on the qualified retirement savings contributions to an employer plan made by an eligible individual. For 2011, only taxpayers filing joint returns with AGI of $56,500 or less, head of household returns with AGI of $42,375 or less, or single returns (or separate returns filed by married taxpayers) with AGI of $28,250 or less, are eligible for the credit. The amount of the credit is equal to the applicable percentage (10% to 50%, based on filing status and AGI) of qualified retirement savings contributions up to $2,000.

Required Minimum Distributions: For 2011, taxpayers must take their required minimum distribution from IRAs or defined contribution plans (§401(k) plans, §403(a) and (b) annuity plans, and §457(b) plans that are maintained by a governmental employer).

Maximize Retirement Savings: In many cases, employers will require you to set your 2012 retirement contribution levels before January 2012. If you did not elect the maximum 401(k) contribution for 2011, you can increase your amount for the remainder of 2011 to lower your AGI in order to take advantage of some of the tax breaks described above. In addition, maximizing your contribution is generally a good tax-saving move.

Deferring Income to 2012

If you expect your AGI to be higher in 2011 than in 2012, or if you anticipate being in the same or a higher tax bracket in 2011, you may benefit by deferring income into 2012. Deferring income will be advantageous so long as the deferral does not bump your income to the next bracket. Deferring income could be disadvantageous, however, if your deferred income is subject to §409A, thus making the income includible in gross income and subject to additional tax. Some ways to defer income include:

Delay Billing: If you are self-employed and on the cash-basis, delay year-end billing to clients so that payments will not be received until 2012.

Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.

Accelerating Income into 2011

In limited circumstances, you may benefit by accelerating income into 2011. For example, you may anticipate being in a higher tax bracket in 2012, or perhaps you will need additional income in order to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note, however, that accelerating income into 2011 will be disadvantageous if you expect to be in the same or lower tax bracket for 2012. In any event, before you decide to implement this strategy, we should “crunch the numbers.”

If accelerating income will be beneficial, here are some ways to accomplish this:

Accelerate Collection of Accounts Receivable: If you are self-employed and report income and expenses on a cash basis, issue bills and attempt collection before the end of 2011. Also see if some of your clients or customers might be willing to pay for January 2012 goods or services in advance. Any income received using these steps will shift income from 2012 to 2011.

Year-End Bonuses: If your employer generally pays year-end bonuses after the end of the current year, ask to have your bonus paid to you before the beginning of 2012.

Retirement Plan Distributions: If you are over age 59¹/₂ and you participate in an employer retirement plan or have an IRA, consider making any taxable withdrawals before 2012.

You may also want to consider making a Roth IRA rollover distribution, as discussed above.

Deduction Planning

Individual Deductions

Deduction timing is also an important element of year-end tax planning. Deduction planning is complex, however, due to factors such as AGI levels and filing status. If you are a cash-method taxpayer, remember to keep the following in mind:

Deduction in Year Paid: An expense is only deductible in the year in which it is actually paid. Under this rule, if your tax rate is going to increase in 2012, it is a smart strategy to postpone deductions until 2012.

Payment by Check: Date checks before the end of the year and mail them before January 1, 2012.

Promise to Pay: A promise to pay or providing a note does not permit you to deduct the expense. But you can take a deduction if you pay with money borrowed from a third party. Hence, if you pay by credit card in 2011, you can take the deduction even though you won’t pay your credit card bill until 2012.

AGI Limits: For 2011, the overall limitation on itemized deductions is terminated. In addition, certain deductions may be claimed only if they exceed a percentage of AGI: 7.5% for medical expenses, 2% for miscellaneous itemized deductions, and 10% for casualty losses.

Standard Deduction Planning: Deduction planning is also affected by the standard deduction. For 2011 returns, the standard deduction is $11,600 for married taxpayers filing jointly, $5,800 for single taxpayers, $8,500 for heads of households, and $5,800 for married taxpayers filing separately. As you can see from the numbers, for 2011, the standard deduction for married taxpayers is twice the amount as that for single taxpayers. If your itemized deductions are relatively constant and are close to the standard deduction amount, you will obtain little or no benefit from itemizing your deductions each year. But simply taking the standard deduction each year means you lose the benefit of your itemized deductions. To maximize the benefits of both the standard deduction and itemized deductions, consider adjusting the timing of your deductible expenses so that they are higher in one year and lower in the following year. You can do this by paying in 2011 deductible expenses, such as mortgage interest due in January 2012.

Medical Expenses: Medical expenses, including amounts paid as health insurance premiums, are deductible only to the extent that they exceed 7.5% of AGI. Consider bunching medical expenses into years when your AGI is lower.

State Taxes: If you anticipate a state income tax liability for 2011 and plan to make an estimated payment, consider making the payment before the end of 2011. Note that in 2011, taxpayers may elect to deduct as an itemized deduction state and local sales taxes instead of state and local income taxes. This benefits taxpayers that reside in states without an income tax. This provision expires at the end of 2011, so you would want to take advantage of it now by making large purchases in 2011 rather than waiting until 2012.

Charitable Contributions: Consider making your charitable contributions at the end of the year. This will give you use of the money during the year and simultaneously permit you to claim a deduction for that year. You can use a credit card to charge donations in 2011 even though you will not pay the bill until 2012. A mere pledge to make a donation is not deductible, however, unless it is paid by the end of the year. Note, however, for claimed donations of cars, boats and airplanes of more than $500, the amount available as a deduction will significantly depend on what the charity does with the donated property, not just the fair market value of the donated property. If the organization sells the property without any significant intervening use or material improvement to the property, the amount of the charitable contribution deduction cannot exceed the gross proceeds received from the sale.

To avoid capital gains, you may want to consider giving appreciated property to charity.

Regarding charitable contributions please remember the following rules: (1) no deduction is allowed for charitable contributions of clothing and household items if such items are not in good used condition or better; (2) the IRS may deny a deduction for any item with minimal monetary value; and (3) the restrictions in (1) and (2) do not apply to the contribution of any single clothing or household item for which a deduction of $500 or more is claimed if the taxpayer includes a qualified appraisal with his or her return. Charitable contributions of money, regardless of the amount, will be denied a deduction, unless the donor maintains a cancelled check, bank record, or receipt from the donee organization showing the name of the donee organization, and the date and amount of the contribution.

A special provision gives taxpayers the ability to distribute tax-free to charity up to $100,000 from a traditional or Roth IRA maintained for an individual whose has reached age 70¹/₂. Ordinarily, such distributions would be taxable to the individual, who would not be able to offset the income fully because of the percentage limitations on charitable contribution deductions. This provision expires at the end of 2011, so you would want to take advantage of it now.

Business Deductions

Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses and dependents as an above-the-line deduction, without regard to the 7.5% of AGI floor.

Equipment Purchases: If you are in business and purchase equipment, you may make a “Section 179 Election,” which allows you to expense (i.e., currently deduct) otherwise depreciable business property. For 2011, you may elect to expense up to $500,000 of equipment costs (with a phase-out for purchases in excess of $2,000,000) if the asset was placed in service during 2011. Also, certain real property can qualify for the expense deduction, but of the $500,000 limitation, only $250,000 can be attributed to qualified real property. Note that for assets placed in service in 2011, taxpayers can expense all of their business equipment purchases under a provision giving taxpayers 100% bonus depreciation, possibly negating the need for the §179 election.

In 2012, the dollar amounts for §179 expensing are scheduled to be $125,000 (with an inflation adjustment), with a phase-out amount of $500,000. Also, the allowance for real property does not apply for 2012.

In addition, careful timing of equipment purchases can result in favorable depreciation deductions in 2011. In general, under the “half-year convention,” you may deduct six months worth of depreciation for equipment that is placed in service on or before the last day of the tax year. (If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.) A popular strategy in recent years is to purchase a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds). Doing so would not subject the purchase to the statutory dollar limit, $11,060 for 2011 (due to bonus depreciation rules); $11,260 in the case of vans and trucks (due to bonus depreciation rules). Therefore, the vehicle would qualify for the full equipment expensing dollar amount. However, for SUVs (rated between 6,000 and 14,000 pounds gross vehicle weight) the expensing amount is limited to $25,000.

NOL Carryback Period: If your business suffers net operating losses for 2011, you generally apply those losses against taxable income going back two tax years. Thus, for example, the loss could be used to reduce taxable income—and thus generate tax refunds—for tax years as far back as 2009. Certain “eligible losses” can be carried back three years; farming losses can be carried back five years.

Bonus Depreciation: Taxpayers can claim 100% bonus depreciation for assets placed in service in 2011. Bonus depreciation is also allowed for machinery and equipment used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials and qualified disaster assistance property. In 2012, the bonus depreciation amount is scheduled to be reduced to 50%.

Education and Child Tax Benefits

Child Tax Credit: A tax credit of $1,000 per qualifying child under the age of 17 is available on this year’s return. In order to qualify for 2011, the taxpayer must be allowed a dependency deduction for the qualifying child. Another qualifying determination is that the qualifying child must be younger than you. The credit is phased out at a rate of $50 for each $1,000 (or fraction of $1,000) of modified AGI exceeding the following amounts: $110,000 for married filing jointly; $55,000 for married filing separately; and $75,000 for all other taxpayers. A portion of the credit may be refundable. For 2011, the threshold earned income level to determine refundability is set by statute at $3,000.

Credit for Adoption Expenses: For 2011, the adoption credit limitation is $13,360 of aggregate expenditures for each child, except that the credit for an adoption of a child with special needs is deemed to be $13,360 regardless of the amount of expenses. The credit ratably phases out for taxpayers whose income is between $185,210 and $225,210. For 2011, the credit is refundable. For 2012, the credit is scheduled to become nonrefundable.

HOPE Credit and Lifetime Learning Credit: Back in 2009, significant changes were put in place for the HOPE, including a name change to the American Opportunity Tax Credit. These changes continue for 2011. The maximum credit for 2011 is $2,500 (100% on the first $2,000, plus 25% of the next $2,000) for qualified tuition and fees paid on behalf of a student (i.e., the taxpayer, the taxpayer’s spouse, or a dependent) who is enrolled on at least a half-time basis. The credit is available for the first four years of the student’s post-secondary education. For 2011, the credit is phased out at modified AGI levels between $160,000 and $180,000 for joint filers, and between $80,000 and $90,000 for other taxpayers. Forty percent of the credit is refundable, which means that you can receive up to $1,000 even if you owe no taxes. The term “qualified tuition and related expenses” includes expenditures for “course materials” (books, supplies, and equipment needed for a course of study whether or not the materials are purchased from the educational institution as a condition of enrollment or attendance). One way to take advantage of the credit for 2011 is to prepay the spring 2012′s tuition. In addition, if your child’s books for the spring semester are known, those can be bought and the costs qualify for the credit.

The Lifetime Learning credit maximum in 2011 is $2,000 (20% of qualified tuition and fees up to $10,000). A student need not be enrolled on at least a half-time basis so long as he or she is taking post-secondary classes to acquire or improve job skills. As with the HOPE (American Opportunity Tax Credit in 2011) credit, eligible students include the taxpayer, the taxpayer’s spouse, or a dependent. For 2011, the Lifetime Learning credit are phased out at modified AGI levels between $102,000 and $122,000 for joint filers, and between $51,000 and $61,000 for single taxpayers.

Coverdell Education Savings Account: For 2011, the aggregate annual contribution limit to a Coverdell education savings account is $2,000 per designated beneficiary of the account. This limit is phased out for individual contributors with modified AGI between $95,000 and $110,000 and joint filers with modified AGI between $190,000 and $220,000. The contributions to the account are nondeductible but the earnings grow tax-free.

Student Loan Interest: You may be eligible for an above-the-line deduction for student loan interest paid on any “qualified education loan.” The maximum deduction is $2,500. The deduction for 2011 is phased out at a modified AGI level between $120,000 and $150,000 for joint filers, and between $60,000 and $75,000 for individual taxpayers.

Kiddie Tax: For 2011, the kiddie tax applies to: (1) children under 18; (2) 18-year old children who have unearned income in excess of the threshold amount, do not file a joint return and who have earned income, if any, that does not exceed one-half of the amount of the child’s support; and (3) children between the ages of 19 and 23 and if, in addition to the above rules, they are full-time students. For 2011, the kiddie tax threshold amount is $1,900.

Energy Incentives

Residential Energy Efficient Property Credit: Until 2016, tax incentives are available to taxpayers who install certain energy efficient property, such as photovoltaic panels, solar water heating property, fuel cell property, small wind energy property and geothermal heat pumps. A credit is available for the expenditures incurred for such property up to a specific percentage, except that a cap applies for fuel cell property. The property purchased cannot be used to heat swimming pools or hot tubs. If you have made improvements to your home or plan to by the end of 2011, please contact me to discuss the amount of the credit you may qualify for.

Nonbusiness Energy Property Credit: For 2011, property qualifying for the nonbusiness energy property credit includes windows (including skylights), exterior doors, insulation, metal roofs, advanced main air circulating fans, natural gas, propane, or oil furnace or hot water boilers, and other energy efficient building property that meets certain energy standards. For 2011, the credit is 10% of the cost of the improvement(s) up to a maximum credit of $500 (therefore, if you took any credit prior to 2011, your total cannot exceed $500). The property must be installed by the end of 2011 to qualify. For 2011, only $200 of the credit can be applied to windows. Also, for 2011, the energy standards are relaxed. The credit expires at the end of 2011.

Business Credits

Small Employer Pension Plan Startup Cost Credit: For 2011, certain small business employers that did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administering a new retirement plan for employees. The credit applies to 50% in qualified administrative and retirement-education expenses for each of the first three plan years. However, the maximum credit is $500 per year.

Employer-Provided Child Care Credit: For 2011, employers may claim a credit of up to $150,000 for supporting employee child care or child care resource and referral services. The credit is allowed for a percentage of “qualified child care expenditures” including for property to be used as part of a qualified child care facility, for operating costs of a qualified child care facility and for resource and referral expenditures.

Work Opportunity Credit: The work opportunity credit is an incentive provided to employers who hire individuals in groups whose members historically have had difficulty obtaining employment. This gives your business an expanded opportunity to employ new workers and be eligible for a tax credit against the wages paid. Wages paid after 2011 are not eligible for the credit.

Credit for Employee Health Insurance Expenses of Small Employers: For tax years beginning after 2009, eligible small employers are allowed a credit for certain expenditures to provide health insurance coverage for its employees. Generally, employers with 10 or fewer full-time equivalent employees (FTEs) and an average annual per-employee wage of $25,000 or less are eligible for the full credit. The credit amount begins to phase out for employers with either 11 FTEs or an average annual per-employee wage of more than $25,000. The credit is phased out completely for employers with 25 or more FTEs or an average annual per-employee wage of $50,000 or more. The credit amount is 35% of certain contributions made to purchase health insurance.

Investment Planning

The following rules apply for most capital assets in 2011:

• Capital gains on property held one year or less are taxed at an individual’s ordinary income tax rate.

• Capital gains on property held for more than one year are taxed at a maximum rate of 15% (0% if an individual is in the 10% or 15% marginal tax bracket).

Note that Congress did extend the reduced capital gains rates, through 2012.

Timing of Sales: You may want to time the sale of assets so as to have offsetting capital losses and gains. Capital losses may be fully deducted against capital gains and also may offset up to $3,000 of ordinary income ($1,500 for married filing separately). In general, when you take losses, you must first match your long-term losses against your long-term gains, and short-term losses against short-term gains. If there are any remaining losses, you may use them to offset any remaining long-term or short-term gains, or up to $3,000 (or $1,500) of ordinary income. When and whether to recognize such losses should be analyzed in light of the possible future changes in the capital gains rates applicable to your specific investments.

Dividends: Qualifying dividends received in 2011 are subject to rates similar to the capital gains rates. Therefore, qualifying dividends are taxed at a maximum rate of 15%. Qualifying dividends include dividends received from domestic and certain foreign corporations. Note that Congress did extend the reduced dividend rates through 2012.

Social Security: Depending on the recipient’s modified AGI and the amount of Social Security benefits, a percentage — up to 85% — of Social Security benefits may be taxed. To reduce that percentage, it may be beneficial to defer receipt of other retirement income. One way to do so is to elect to receive a lump sum distribution from a retirement plan and to rollover that distribution into an IRA. Alternatively, it may be beneficial to accelerate income so as to reduce the percentage of your Social Security taxed in 2012 and later years.

Other Tax Planning Opportunities: We also can discuss the potential benefits to you or your family members of other planning options available for 2011, including §529 qualified tuition programs.

Alternative Minimum Tax

For 2011, the alternative minimum tax exemption amounts will remain high enough to spare millions of taxpayers from the AMT effect. The exemption amounts in place for 2011 are: (1) $74,450 for married individuals filing jointly and for surviving spouses; (2) $48,450, for unmarried individuals other than surviving spouses; and (3) $37,225 for married individuals filing a separate return. Also, for 2011, nonrefundable personal credits can offset an individual’s regular and alternative minimum tax.

Some of the standard year-end planning ideas will not reduce tax liability if you are subject to the alternative minimum tax (AMT) because different rules apply. Because of the complexity of the AMT, it would be wise for us to analyze your AMT exposure.

If you have any questions, please do not hesitate to contact Paul by clicking here. While we are getting very close to the end of the year, there is still time to implement these strategies to minimize your 2011 tax liability.

2011 Year-End Tax Planning for Businesses

paul — Thu, 10 Nov 2011 15:16:55 +0000

As 2011 draws to a close, there is still time to reduce your 2011 tax bill and plan ahead for 2012. This post highlights several potential tax-saving opportunities for you to consider. I would be happy to meet with you to discuss specific strategies and issues.

Deferring Income to 2012

Deferring income to the next taxable year is a time-honored year-end plan. If you expect your AGI to be higher in 2011 than in 2012, or if you anticipate being in the same or a higher tax bracket in 2011 than in 2012, you may benefit by deferring income into 2012. Some ways to defer income include:

Use of Cash Method of Accounting: By using the cash method of accounting instead of the accrual method of accounting, you can generally put yourself in the best position for accelerating deductions and deferring income. There is still time to accomplish this strategy, because an automatic change to the cash method can be made by the due date of the return including extensions. The following three types of businesses can make an automatic change to the cash method: (1) small businesses with average annual gross receipts of $1 million or less (even those with inventories that are a material income producing factor); (2) certain C corporations with average annual gross receipts of $5 million or less in which inventories are not a material income producing factor; and (3) certain taxpayers with average annual gross receipts of $10 million or less. Provided inventories are not a material income producing factor, sole proprietors, limited liability companies (LLCs), partnerships, and S corporations can change to the cash method of accounting without regard to their average annual gross receipts.

Delay Billing: Delay year-end billing to clients so that payments are not received until 2012.

Interest and Dividends: Interest income earned on Treasury securities and bank certificates of deposit with maturities of one year or less is not includible in income until received. To defer interest income, consider buying short-term bonds or certificates that will not mature until next year. If you have control as to when dividends are paid, arrange to have them paid to you after the end of the year.

Accelerating Income into 2011

You may benefit from accelerating income into 2011. For example, you may anticipate being in a higher tax bracket in 2012, or perhaps you need additional income in 2011 to take advantage of an offsetting deduction or credit that will not be available to you in future tax years. Note, however, that accelerating income into 2011 will be disadvantageous if you expect to be in the same or lower tax bracket for 2012.

If you report income and expenses on a cash basis, issue bills and attempt collection before the end of 2011. Also see if some of your clients or customers are willing to pay for January 2012 goods or services in advance. Any income received using these steps will shift income from 2012 to 2011.

Business Deductions

Self-Employed Health Insurance Premiums: Self-employed individuals are allowed to claim 100% of the amount paid during the taxable year for insurance that constitutes medical care for themselves, their spouses, and their dependents as an above-the-line deduction, without regard to the 7.5%-of-AGI floor.

Equipment Purchases: If you purchase equipment, you may make a “Section 179 election,” which allows you to expense (i.e., currently deduct) otherwise depreciable business property. For 2011, you may elect to expense up to $500,000 of equipment costs (with a phase-out for purchases in excess of $2,000,000) if the asset was placed in service during 2011. Also, certain real property can qualify for the expense deduction, but—of the $500,000 limitation—only $250,000 can be attributed to qualified real property. Note that for assets placed in service in 2011, taxpayers can expense all of their business equipment purchases under a provision giving taxpayers 100% bonus depreciation. In 2012, the dollar amounts for §179 expensing are scheduled to be $139,000, with a phase-out amount of $560,000. Also, the allowance for real property does not apply for 2012. In addition, careful timing of equipment purchases can result in favorable depreciation deductions in 2011. In general, under the “half-year convention,” you may deduct six months’ worth of depreciation for equipment that is placed in service on or before the last day of the tax year. (If more than 40% of the cost of all personal property placed in service occurs during the last quarter of the year, however, a “mid-quarter convention” applies, which lowers your depreciation deduction.) A popular strategy in recent years is to purchase a vehicle for business purposes that exceeds the depreciation limits set by statute (i.e., a vehicle rated over 6,000 pounds). Doing so would not subject the purchase to the statutory dollar limit, $11,060 for 2011 (due to bonus depreciation rules), $11,260 in the case of vans and trucks (due to bonus depreciation rules). Therefore, the vehicle would qualify for the full equipment expensing dollar amount. However, for SUVs (rated between 6,000 and 14,000 pounds gross vehicle weight) the expensing amount is limited to $25,000.

NOL Carryback Period: If your business suffers net operating losses for 2011, you generally apply those losses against taxable income going back two tax years. Thus, for example, the loss could be used to reduce taxable income—and thus generate tax refunds—for tax years as far back as 2009. Certain “eligible losses” can be carried back three years; farming losses can be carried back five years.

Bonus Depreciation: Taxpayers can claim 100% bonus depreciation for assets placed in service in 2011. Bonus depreciation is also allowed for machinery and equipment used exclusively to collect, distribute, or recycle qualified reuse and recyclable materials and qualified disaster assistance property. In 2012, the bonus depreciation amount is scheduled to be reduced to 50%. A contractor using the percentage-of-completion method of determining taxable income from a long-term contract does not need to take bonus depreciation into account in determining the cost of property otherwise eligible for bonus depreciation that has a MACRS recovery period of seven years or less and is placed in service during 2010 for most property, but placed in service in 2011 for long-production-period property.

Bad Debts: You can accelerate deductions to 2011 by analyzing your business accounts receivable and writing off those receivables that are totally or partially worthless. By identifying specific bad debts, you should be entitled to a deduction. You may be able to complete this process after year-end if the write-off is reflected in the 2011 year-end financial statements.

Home Office Deduction: Expenses attributable to using the home office as a business office are deductible under §280A if the home office is used regularly and exclusively: (1) as a taxpayer’s principal place of business for any trade or business; (2) as a place where patients, clients, or customers regularly meet or deal with the taxpayer in the normal course of business; or (3) in the case of a separate structure not attached to the residence, in connection with a trade or business.

Basis Adjustment to Stock of S Corporations Making Charitable Contributions of Property: Section 1367(a)(2) provides that an S corporation shareholder’s §1367(a)(2)(B) basis reduction resulting from the corporation’s charitable contribution of property equals the shareholder’s pro rata share of the adjusted basis of the contributed property. This special rule expired at the end of 2009, but the 2010 Tax Relief Act revived it and extended its availability to contributions made on or before December 31, 2011.

Business Credits

Small Employer Pension Plan Startup Cost Credit: For 2011, certain small business employers that did not have a pension plan for the preceding three years may claim a nonrefundable income tax credit for expenses of establishing and administering a new retirement plan for employees. The credit applies to 50% of qualified administrative and retirement-education expenses for each of the first three plan years. However, the maximum credit is $500 per year.

Employer-Provided Child Care Credit: For 2011, employers may claim a credit of up to $150,000 for supporting employee child care or child care resource and referral services. The credit is allowed for a percentage of “qualified child care expenditures,” including for property to be used as part of a qualified child care facility, for operating costs of a qualified child care facility, and for resource and referral expenditures.

Work Opportunity Credit: The work opportunity credit is an incentive provided to employers who hire individuals in groups whose members historically have had difficulty obtaining employment. The credit gives a business an expanded opportunity to employ new workers and to be eligible for a tax credit against the wages paid. Wages paid after 2011 are not eligible for the credit.

Credit for Employee Health Insurance Expenses of Small Employers: Eligible small employers are allowed a credit for certain expenditures to provide health insurance coverage for their employees. Generally, employers with 10 or fewer full-time equivalent employees (FTEs) and an average annual per-employee wage of $25,000 or less are eligible for the full credit. The credit amount begins to phase out for employers with either 11 FTEs or an average annual per-employee wage of more than $25,000. The credit is phased out completely for employers with 25 or more FTEs or an average annual per-employee wage of $50,000 or more. The credit amount is 35% of certain contributions made to purchase health insurance.

Differential Wage Pay Credit: The 2010 Tax Relief Act revived the differential pay credit (which had expired at the end of 2009) and extended the availability of the credit to amounts paid on or before December 31, 2011. Therefore, if an employer meets certain qualification requirements, it can take a credit against its 2011 income tax liability in an amount equal to 20% of the sum of the “differential wage payments,” up to $20,000, that the employer makes to an employee in active duty in the military.

Inventories

Subnormal Goods: You should check for subnormal goods in your inventory. Subnormal goods 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, including second-hand goods taken in exchange. If your business has subnormal inventory as of the end of 2011, you can take a deduction for any write-downs associated with that inventory provided you offer it for sale within 30 days of your inventory date. The inventory does not have to be sold within the 30-day timeframe.

Other 2011 Opportunities

S Corporation Built-In Gains Tax: An S corporation generally is not subject to tax; instead, it passes through its income or loss items to its shareholders, who are taxed on their pro-rata shares of the S corporation’s income. However, if a business that was formed as a C corporation elects to become an S corporation, the S corporation is taxed at the highest corporate rate on all gains that were built in at the time of the election if the gains are recognized during a special holding period. While for tax years beginning in 2009 and 2010, the special holding period was shortened from 10 years to seven years, it is shortened even more for tax years beginning in 2011, to five years.

100% Exclusion of Gain Attributable to Certain Small Business Stock: The incentive for individuals to acquire qualified small business stock is higher before the end of 2011. An individual ordinarily may exclude 50% of the gain from qualified small business stock that is held for at least five years (subject to a cap). “Qualified small business stock” is stock of a corporation the assets of which do not exceed $50 million when the stock is issued. The 50% exclusion of gain was increased to 75% for qualified small business stock acquired after February 17, 2009, and before September 28, 2010. The 2010 Small Business Jobs Act excluded 100% of the gain for qualified small business stock acquired or issued after September 27, 2010, and before January 1, 2011, and the 2010 Tax Relief Act extended the 100% exclusion to qualified small business stock acquired before January 1, 2012. In addition, the alternative minimum tax preference item attributable to the sale is eliminated.

Qualified Dividends: Qualified dividends received in 2011 are subject to rates similar to the capital gains rates. Therefore, qualified dividends are taxed at a maximum rate of 15%. Qualified dividends are typically dividends from domestic and certain foreign corporations. Note that the reduced dividend rates apply through 2012.

Reporting

Uncertain Tax Positions: A corporation needs to file new Schedule UTP, Uncertain Tax Position Statement, with its 2011 income tax return if it: (1) files Form 1120, Form 1120-F, Form 1120-L, or Form 1120-PC; (2) has assets of at least $100 million (a threshold amount that will drop starting with 2012 tax years); (3) issued (or a related party issued) audited financial statements reporting all or a portion of the corporation’s operations for all or a portion of the corporation’s tax year; and (4) has one or more “uncertain tax positions” (UTPs). A UTP is a tax position that will result in an adjustment to a line item on a return if the position is not sustained, provided the corporation has taken the position for the current or a prior tax year and the corporation (or a related party) either recorded a reserve for the position or did not record a reserve because it expects to litigate the position.

Electronic Deposits

Electronic Funds Transfer: As of January 1, 2011, a corporation must make its deposits of income tax withholding, FICA, FUTA, and corporate income tax by electronic funds transfer (EFT), including through the IRS’s Electronic Federal Tax Deposit System (EFTPS).

If you would like to meet to discuss specific strategies and issues regarding tax planning for 2011 as the year draws to a close click here to contact Paul.

Preparing for an IRS Audit? Watch this video and give me a call.

paul — Thu, 13 Oct 2011 15:22:13 +0000

As I get ready to represent a taxpayer in an audit I will often send them a link to an interactive video that is very helpful in explaining the examination process. This video is published by the IRS and explains what to expect in an IRS audit, the steps that are typically followed, and gives you insight into the process if you agree or disagree with the IRS’s findings. The video discusses your right to have representation during an audit. While I think that the video does have some shortcomings, it does a pretty good job of providing an overview of the entire IRS audit process.

Here is the link: http://www.irsvideos.gov/audit/

If you have received notice that your tax return or returns have been selected for audit by the IRS, I recommend that you watch the video and seek representation. As a an attorney and CPA, representing taxpayers before the IRS is a regular part of my practice. I represent taxpayers at the administrative level and in the tax court when taxpayer’s cannot not come to an agreement with the IRS. Click here to contact me to discuss your situation.

IRS Innocent Spouse Policy Changes | Form 8857

paul — Thu, 29 Sep 2011 20:29:10 +0000

By requesting innocent spouse relief, you can be relieved of responsibility for paying tax, interest, and penalties if your spouse (or former spouse) improperly reported items or omitted items on your tax return. One method of such “relief” is obtain through “equitable grounds” under Internal Revenue Code §6015(f). The IRS originally established a two-year deadline for requesting equitable relief to encourage prompt resolution and to consider evidence while it remained available. Effective July 25, 2011, however, the IRS no longer requires that a spouse submit a request for equitable relief within two years of when the IRS first began collection activity against such spouse.

The elimination of the two-year deadline means that an individual seeking to avoid joint liability for tax because of the other spouse’s actions may file a request for equitable relief within 10 years of the IRS’s assessment of tax, penalties and interest for the year(s) at issue. If one is seeking a credit or refund of tax, the request for equitable relief generally must be filed within three years from the time the return was filed or two years from the time the tax was paid, whichever period expires later. (If no return was filed, the claim for credit or refund generally must be made within two years from the time the tax was paid).

If you have already submitted a request for relief under §6015(f), the IRS will consider the request even though it was submitted more than two years after the IRS first began collection activity against you, so long as the limitations periods described above were open when the request was originally filed.

If your request for innocent spouse relief under §6015(f) was denied and the decision was never appealed to a court, you may reapply for relief by filing a new Form 8857, Request for Innocent Spouse Relief. The good news is that the IRS will treat the original Form 8857 as a claim for refund for purposes of the refund limitations period described above, thus any amount for which a refund was available as of the date the original Form 8857 was filed, and any amounts later collected by the IRS, may be refunded if relief is granted. The IRS will only grant relief for unpaid liabilities if the period of limitations on collection described above remains open as of the date of the reapplication.

If your request under §6015(f) was litigated and the case is now final, then although the court in your case denied relief on the grounds that the request was made after the IRS’s two-year deadline (and the decision is final), because the IRS agreed that your request for relief would have been granted had it been filed within the two-year window, the change in the IRS’s policy described above means that they no longer will seek to collect from you the underlying liability for which equitable relief would have been granted. However, the IRS may pursue collection of other unpaid tax liabilities.

If you have questions about innocent spouse relief contact Paul by clicking here.

Making the S Corporation Election

paul — Tue, 16 Aug 2011 14:41:34 +0000

This post discusses how a corporation may make an election to be treated as an S corporation for federal tax purposes. A corporation may become an S corporation if:

(1) it meets the requirements of S corporation status;

(2) all its shareholders consent to S corporation status;

(3) it files Form 2553, Election by a Small Business Corporation, to indicate it chooses S corporation status; and

(4) it uses a permitted tax year, or elects to use a tax year other than a permitted tax year (explained below) .

All of these requirements are discussed further below.

Requirements of an S Corporation

To qualify for S corporation status, a corporation must meet all the following requirements:

(1) It must be a domestic corporation. In other words, it must be a corporation that is either organized in the United States or organized under federal or state law.

(2) It must have only one class of stock.

(3) Generally, it must have no more than 100 shareholders.

(4) It must have as shareholders only individuals, estates, and certain trusts; certain pension plans and certain charities may also be shareholders.

(5) All of its shareholders must be either citizens or residents of the United States. Nonresident aliens may not be shareholders.

One Class of Stock

“One class of stock” generally means that the outstanding shares of the corporation must be identical as to the rights of the holders in the profits and assets of the corporation. Stock may have differences in voting rights and still be considered one class of stock, if all other rights are identical. A stock purchase agreement executed between an S corporation and its shareholders that does not affect the shareholder’s rights in the corporation’s profits and assets will not create a second class of stock. Debt obligations of a corporation that are actually contributions of equity capital may be treated as a second class of stock. However, straight debt will not be considered a second class of stock. The term “straight debt” means any written unconditional promise to pay a fixed amount on demand or on a specified date, if:

(1) the interest rate and interest payment dates are not contingent on profits, the borrower’s discretion, or similar facts;

(2) the debt cannot be converted, directly or indirectly, into stock; and

(3) the creditor is an individual, estate, or trust eligible to hold stock in an S corporation; banks can also hold straight debt.

Shareholder Consents

The corporation’s election of S corporation status is valid only if all shareholders consent to the election. Once made, the S election may be revoked only if shareholders who collectively own more than 50% of the outstanding shares of the corporation’s stock consent to the revocation. Shareholders may consent by providing the required information on Form 2553 and signing in the appropriate place on that form. All shareholders must consent at the time the Form 2553 is filed. If the consent is filed after the beginning of the year for which it is to be effective, all shareholders in the corporation who held stock on any day in the tax year before the date the Form 2553 is filed must also consent.

Form 2553

The corporation must qualify as an S corporation when it files its Form 2553. The Form 2553 should be filed with the IRS Service Center where the S corporation will file its income tax return. The election of S corporation status applies to a particular tax year if the Form 2553 is filed:

(1) any time during the previous tax year; or

(2) by the 15th day of the third month of the tax year.

A “late” or invalid election can cause adverse tax consequences. Extreme care should be exercised to ensure that the Form 2553 is accurately completed and filed in a timely manner. Although the IRS may treat a late or invalid election as timely and valid if reasonable cause is shown, it is far preferable to ensure that the requirements are met.

Tax Year

A permitted tax year is a calendar year or any other accounting period for which the corporation establishes a business purpose to the IRS’s satisfaction. In addition, an S corporation may elect under §444 of the Internal Revenue Code to have a tax year other than a permitted tax year. A corporation electing S corporation status does not need the IRS’s approval to choose a calendar year as its tax year. An electing S corporation should use Form 2553 to request a tax year other than a calendar year or to make the §444 election.

If your corporation needs assistance making the election to be taxed as an S corporation contact Paul by clicking here.

Auto, Car, and Truck Business Expenses

paul — Sun, 19 Jun 2011 20:42:29 +0000

Many business owners purchase vehicles that are used extensively for business purposes and need to know to what extent this business use is deductible from their income. Taxpayers who use a passenger automobile, including “luxury” automobiles, in the pursuit of business or in an income-producing activity can deduct certain costs related to its acquisition and maintenance. The deductible items include gas, oil, tolls, parking fees, insurance, and depreciation (if you own the car) or rent (if you lease the car). All of the expenses must be allocated between business use and nondeductible personal use. Use of an automobile for commuting to and from work is personal and expenses related to commuting are nondeductible. You can deduct actual expenses incurred as a result of the business use or you can use the standard mileage rate.

Instead of figuring actual expenses, you can use the standard mileage rate of 51 cents per mile for travel during 2011. The standard mileage deduction is in lieu of deducting operating and fixed costs of the automobile. Depreciation is a component of the standard mileage rate, therefore, the basis in the automobile must be reduced by the depreciation allowed. However, if you use the standard mileage deduction, you can still deduct parking fees, tolls, interest relating to the automobile’s purchase, and state and local taxes. Up to four cars used simultaneously can be computed using the standard mileage rate.

If you want to use the standard mileage rate for a car in any year, you must choose to use it in the first year you place the car in service in your business. After the first year you can switch to deducting actual expenses.

If you choose to deduct actual expenses, you can deduct such items as oil, gas, insurance, depreciation, etc. However, there are special rules that apply if you use your car 50% or less in your business. Generally, you must use a car more than 50% for business to qualify for the §179 deduction (election to treat a portion of the cost of the car as an expense-see below) and there is a limit on the depreciation deduction. Using your car as an employee is treated as business use only if that use is for the convenience of your employer and required as a condition of your employment.

Generally, the cost of an automobile is a capital expenditure; however, if you use the automobile more than 50% for business purposes, you can elect to treat a portion of the cost, subject to yearly limits, as an expense in the year the automobile is placed in service. The yearly limit allowed is determined by the year the automobile is placed in service and the percentage of business use. A special rule for 2008, 2009, and 2010 allows an additional 50% first-year depreciation deduction and an $8,000 increase to the annual limitation amount.

For example, if an automobile is placed in service in 2010, the expense deduction and the depreciation deduction cannot be more than $11,060 for the first year (the placed-in-service year); $4,900 for the second year; $2,950 for the third year, and $1,775 for any year thereafter. This limit is reduced if the taxpayer uses the automobile more than 50%, but less than 100%, for business use.

Vans and trucks placed in service in 2010 are subject to a higher limitation than passenger automobiles: $11,160 for the first year; $5,100 for the second year; $3,050 for the third year; and $1,875 for each succeeding year. Vans and trucks placed in service in 2009 are subject to the following limitations: $11,060 for the first year; $4,900 for the second year; $2,950 for the third year; and $1,775 for each succeeding year.

Trucks used in construction and other certain activities may not be subject to these limitations. Large SUVs are also subject to different rules as well. If you would like more information about auto, car, and truck expenses in your business, click here to contact Paul to discuss the matter further.