Accounting and Tax Tips

IRS Releases Guidance on How to Claim Expanded Veterans Tax Credit; Certification Requirements Streamlined

2012-02-09T13:58:00.000-06:00

WASHINGTON — The IRS today released the guidance and forms that employers can use to claim the newly-expanded tax credit for hiring veterans. The IRS also announced that employers will have more time to file the required certification form for employees hired on or after November 22, 2011, and before May 22, 2012. The VOW to Hire Heroes Act of 2011, enacted Nov. 21, 2011, provides an expanded Work Opportunity Tax Credit (WOTC) to businesses that hire eligible unemployed veterans and for the first time also makes the credit available to certain tax-exempt organizations.

The credit can be as high as $9,600 per veteran for for-profit employers or up to $6,240 for tax-exempt organizations. The amount of the credit depends on a number of factors, including the length of the veteran’s unemployment before hire, hours a veteran works and the amount of first-year wages paid. Employers who hire veterans with service-related disabilities may be eligible for the maximum credit.

Normally, an eligible employer must file Form 8850 with the state workforce agency within 28 days after the eligible worker begins work. But according to today’s guidance, employers have until June 19, 2012, to complete and file this newly-revised form for veterans hired on or after Nov. 22, 2011, and before May 22, 2012. The 28-day rule will again apply to eligible veterans hired on or after May 22, 2012.

In an effort to streamline the certification requirements, IRS today clarified and expanded upon 2002 guidance to facilitate employers’ use of electronic signatures when gathering the Form 8850 for transmission to state workforce agencies. The guidance confirms that employers can transmit the Form 8850 electronically, and also allows employers to transmit the Form 8850 via fax, subject to the ability of the state workforce agencies to accept submissions in those formats. The IRS expects the Department of Labor to issue further guidance to the state workforce agencies providing further clarification.

Notice 2012-13, posted today on IRS.gov, and the instructions for Form 8850 provide further details.

Businesses claim the credit on their income tax return. The credit is first figured on Form 5884 and then becomes a part of the general business credit claimed on Form 3800.

This credit is also available to certain tax-exempt organizations by filing Form 5884-C. The guidance released today also provides instructions and a new set of forms for tax-exempt organizations to claim the credit. For more information, including how to claim the credit, go to IRS.gov.

Failure to File Correct Form W-2 by Due Date

2012-02-08T12:29:00.000-06:00

Employers who fail to file a correct Form W-2 by the due date are subject to the following penalty, which is based on when a correct Form W-2 is filed:

(1) $30 per Form W-2 if correctly filed within 30 days after the due date (by March 30 if the due date is February 28), up to a maximum of $250,000 a year ($75,000 for certain small businesses);

(2) $60 per Form W-2 if correctly filed more than 30 days after the due date but by August 1, up to a maximum of $500,000 a year ($200,000 for small businesses); and

(3) $100 per Form W-2 if filed after August 1 or not filed, up to a maximum of $1,500,000 a year ($500,000 for small businesses).

Failure to file correctly means failure to include all information required to be shown on Form W-2, including:

* incorrect information,

* filing on paper when filing electronically is required,
* reporting an incorrect taxpayer identification number (TIN),

* failing to report a TIN, or

* failing to file paper Forms W-2 that are machine readable.

An inconsequential error or omission is not considered a failure to include correct information. However, errors and omissions relating to a TIN, a payee's surname, and money amounts are never considered inconsequential (Code Sec. 6721; Reg. §§301.6721-1(a)(2), 301.6721-1(c)).

IRS Indicates 2012 Filing Season Brings Many New Changes

2012-02-08T12:25:00.000-06:00

The 2012 filing season brings in many changes for tax return preparers and taxpayers, reported IRS officials Preston Benoit, deputy director of Return Preparer Office, and Jason Langley, lead tax law specialist of Tax Forms and Publications.

At a January 10 webcast hosted by Tax Talk Today, Benoit outlined the format of the registered return preparer competency exam, which is required for return preparers who want to be designated as Registered Tax Return Preparers. Langley also discussed changes to existing forms and the introduction of new tax forms for the 2012 filing season.

Comment

Some of the new forms are Form 8949 for reporting capital gains and losses, and an updated Form 1040-EZ and Form 1040-NR-EZ, which will reflect the payroll tax cut legislation when they are released in the next few months.

Competency Test

As part of its initiative to improve the return preparer industry, the IRS, in 2011, began requiring that return preparers who are not attorneys, CPAs or enrolled agents, must obtain a Preparer Tax Identification Number (PTIN). The second prong of the initiative requires that return preparers pass the registered tax return preparer competency test by December 31, 2013.

"The exam is a basic minimal competency exam," Benoit explained. "The examination is 120 questions; they're all mostly multiple choice or true and false." Exam takers are not allowed to bring prepared materials or notes with them into the exam, but the IRS will provide several resources such as Publication 17, the Tax Guide, and the long version of Form 1040 and its instructions. Benoit cautioned that the exam "is structured in such a way that, if a taker has to look up each and every answer, there may be trouble." The IRS will provide review materials on its website (http://www.irs.gov), and the likelihood of commercial study courses arising in the next two years should enable exam takers to more than adequately prepare for the test. For those who do not pass the exam on the first try, Benoit explained, "They can take the exam as many times as necessary."

Fingerprinting

In the meantime, return preparers who have not yet applied for their PTIN must do so. Benoit reported that the IRS has released applicants from the controversial fingerprinting requirement, although they are still subject to checks on their tax compliance status.

Registered Tax Return Preparer Status

Registered Tax Return Preparers who have passed the competency exam must maintain their status by annually renewing their PTIN and obtaining a minimum of 15 continuing education credits. These include two hours of ethics or professional conduct, three hours of federal tax law updates and 10 hours of federal tax law topics. Attorneys, CPAs and enrolled agents are subject to requirements of their own states, bar associations or other professional organizations and are generally not required to fulfill the IRS continuing education requirements. They must, however, still annually renew their PTINs.

2011 Tax Form Changes

There will be fewer processing delays for the 2011 tax year than there were for 2010. The delays in 2011 were due mainly to the last-minute tax legislation passed by Congress in 2010. "Because there is a lot of last-minute give-and-take to reach a deal, sometimes behind closed doors, we never know what the final legislation is going to be," said Langley. But he offered his assurances: "We don't expect to have any delays for 2011."

Some important changes to the 2011 tax forms include:

Form 1040. Form 1040 now has several blanks where taxpayers may directly input their foreign addresses, eliminating the need to file that information on a separate form.

Schedule L. Schedule L will no longer be required to figure the standard deduction.

Form 1040 and Individual Tax Return Identity Theft. The IRS has included a box for the identity theft protection PIN for victims of identity theft. It appears on the bottom of the second page, to the right of the blank for the spouse's occupation. Taxpayers who suffered identity theft (that is, someone whose information was used to file a fraudulent tax return and not simply someone whose credit cards were stolen) should have received a letter from the IRS at the end of 2011 that contained their PIN. Langley warned e-filers that they must include their PIN. "If they don't enter the PIN, and they received the letter, the return will probably be rejected." Additionally, â€˜if they have lost the PIN, there is nothing they can do."

Foreign Financial Assets. Form 8938, Statement of Specified Foreign Financial Assets, has been released. Because of the penalties associated with the failure to file this form when required, preparers and taxpayers should familiarize themselves with the form and its instructions. "They define exactly what a foreign financial asset is, which I think is going to confuse a lot of people," said Langley.

Capital Gains and Losses. Schedule D, which traditionally was used to report capital gains and losses, has been replaced by Form 8949. Schedule D is now a recapitulation of items appearing elsewhere. The new system may change in the future as the IRS receives feedback. "We did focus test the 8949 as we developed itâ€¦and Schedule D as well," said Langley. "And depending on the feedbackâ€¦there will be further changes, I'm sure, to tweak this."

Refundable Credits. Finally, Langley stated that taxpayers who qualify for some refundable credits, such as the adoption credit or the first-time homebuyer credit, must file their returns on paper.

IRS Issues 2011-2012 Priority Guidance Plan

2012-02-08T12:20:00.000-06:00

The IRS has issued the priority guidance plan for 2011-2012. The payroll related items relating to executive compensation, health care, and benefits are below.

(1) Guidance under Code Sec. 51(d) on whether a state workforce agency may accept a Form 8850 Pre-Screening Notice and Certification Request for the Work Opportunity Credit with faxed signatures of the job applicant and the employer.

(2) Revenue ruling under Code Sec. 62(c) on wage recharacterization.

(3) Regulations under Code Sec. 83 to incorporate the holding in Revenue Ruling 2005-48.

(4) Revenue procedure providing model language on Code Sec. 83(b) elections.

(5) Final regulations on cafeteria plans under Code Sec. 125.

(6) Guidance on the $2,500 annual limit on salary reduction contributions to cafeteria plan health Flexible Spending Arrangements (health FSAs) under Code Sec. 125(i), as added by §9005 of the Patient Protection and Affordable Care Act (ACA).

(7) Notice on the applicability of Code Sec. 132(d) and (e) to employer-provided cell phones following enactment of §2043 of the Small Business Jobs Act of 2010. Published: 9/19/11 in IRB 2011-38 as Notice. 2011-72 (Released 9/14/11).

(8) Guidance under Code Sec. 132(f) on the use of smart cards, debit cards and credit cards in providing qualified transportation fringe benefits.

(9) Guidance under Reg. §162(m) on the application of the deduction limitation to certain payments of dividends or dividend equivalents.

(10) Guidance under Code Sec. 162(m)(6), as added by §9014 of the ACA.

(11) Notice under Code Sec. 223 on the effect of Indian Health Service coverage on eligibility to contribute to a Health Savings Account (HSA).

(12) Revenue ruling under Code Sec. 280G and Code Sec. 4999(a) on change in ownership.

(13) Guidance on application of Code Sec. 402(b) to participants in foreign nonqualified deferred compensation plans.

(14) Guidance under Code Sec. 404 on the application of the "in which or with which ends" rule and the exceptions to that rule in Code Sec. 1.404(a)-12(b).

(15) Final regulations on income inclusion under Code Sec. 409A. Proposed regulations were published on December 8, 2008.

(16) Notice on the application of Code Sec. 409A(b), as amended by the Pension Protection Act of 2006.

(17) Guidance under Code Sec. 419A on the definition of post-retirement medical benefits.

(18) Guidance under Code Sec. 424(c)(1)(B) on whether there is a disposition of Incentive Stock Option or Employee Stock Purchase Plan shares on receipt of boot by a target shareholder in a Code Sec. 368(a)(1) reorganization.

(19) Regulations under Code Sec. 457(f) on ineligible plans.

(20) Regulations under Code Sec. 512 explaining how to compute unrelated business taxable income of voluntary employees' beneficiary associations described in Code Sec. 501(c)(9).

(21) Guidance on the employee retention credit under Code Sec. 1400R.

(22) Regulations under Code Sec. 3101(b), Code Sec. 3102(f), and Code Sec. 1401(b) on additional Medicare tax on employees and self-employed individuals as added by §9015 of the ACA.

(23) Revenue ruling under Code Sec. 3121(q) updating Revenue Ruling 95-7 on tips.

(24) Regulations under Code Sec. 3127, Code Sec. 3121(b)(3)(A) and Code Sec. 3306(c)(5) making certain FICA exemptions available for disregarded entities.

(25) Regulations under Code Sec. 3504 designating certain parties who file employment tax returns under their employer identification numbers (EINs) for their clients' workers as persons required to perform acts of employers.

(26) Regulations under Code Sec. 4980G on interaction of Code Sec. 4980G and Code Sec. 125 with respect to comparable employer contributions to employees' HSAs.

(27) Guidance on shared responsibility for employers regarding health coverage under Code Sec. 4980H, as added by §1513 of the ACA. Published: 10/3/11 in IRB 2011-40 as Notice 2011-73 (Released 9/13/11).

(28) Guidance on the reporting requirements under Code Sec. 6056, as added by §1514 of the ACA.

(29) Guidance on the tax treatment of health insurance premium rebates under Public Health Service Act Code Sec. 2718(b), as added by §1001 of the ACA. (Treasury Office of Tax Policy and Internal Revenue Service,Second Quarter 2011-2012 Priority Guidance Plan, January 25, 2012.)

IRS Reopens Offshore Voluntary Disclosure Program and Increases Top Penalty

2012-02-03T13:04:00.000-06:00

The IRS has reopened the offshore voluntary disclosure program, which closed in 2011, to encourage taxpayers to disclose unreported foreign accounts. The revived program is open-ended, but the IRS reserved the right to change the terms of the program at any time going forward (IRS News Release 2012-5). Additional details will be posted on the IRS website, the IRS advised.

Comment

IRS Commissioner Douglas Shulman announced the reopening of the offshore voluntary disclosure program by lauding the success of past programs. Shulman reported that the IRS has collected $4.4 billion from the 2009 and 2011 programs. Shulman predicted the IRS will collect additional revenue from the 2011 program as it processes cases.

The reopened program is similar to the 2011 program, but there are some differences. The overall penalty framework requires individuals to pay a penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to disclosure.

The 2011 program imposed a penalty of 25 percent. Unchanged from the 2011 program are reduced penalties of 12.5 percent and five percent for qualified taxpayers, the IRS explained. Individuals who have made voluntary disclosures after the 2011 program ended will be able to be treated under the provisions of the revived program.

The 2009 and 2011 programs were temporary and required taxpayers to request to participate by certain deadlines. The reopened program has no set deadline. However, the terms of the revived program could change at any point, the IRS cautioned. The IRS indicated it could increase penalties in the program for all, or some, taxpayers or defined classes of taxpayers; or, it could decide to end the revived program entirely.

Comment

Shulman reported that the 2009 and 2011 programs have generated 33,000 voluntary disclosures to date.

In related news, the National Taxpayer Advocate recently has ordered the IRS Large Business & International and Small Business/Self-Employed Divisions in a Taxpayer Assistance Directive (TAD) to revoke a memorandum issued on March 1, 2011, to examiners of open cases in the 2009 offshore voluntary disclosure program. The memorandum directs examiners in certain listed categories of cases to stop using their discretion to determine whether to propose an offshore penalty less than 20 percent.

Comment

According to the National Taxpayer Advocate, the IRS materially changed the terms of the 2009 offshore voluntary disclosure program after taxpayers, who relied on the original terms, applied for it. This resulted in the IRS treating similarly situated taxpayers differently.

Reference: PTE §39,015.15

FUTA Reminders for 2012

2012-02-01T11:14:00.001-06:00

All of the states have now announced their taxable wage bases for 2012. As usual, there are a number of increases over the wage bases set last year. In addition, Nevada has a decrease in its taxable wage base for 2012. In the table below, states having higher 2012 wage bases than the 2011 wage bases are printed in bold. Nevada, with its lower amount, appears in italics.

FUTA tax figures for 2012

The taxable wage base under the Federal Unemployment Tax Act remains $7,000 for 2012. In addition, all 50 states, as well as the District of Columbia, Puerto Rico and the Virgin Islands, have received certifications for the maximum additional credit allowable based on the 12-month period ending on October 31, 2011.

0.2% surtax expires

The FUTA tax rate is 6.2% for wages paid on or after January 1, 2011, through June 30, 2011. It decreases to 6.0% for wages paid after July 1, 2011, through December 31, 2011, because of the mid-year expiration of the FUTA surtax. As we go to press, there has been no legislation reenacting the surtax for either the latter part of 2011 or for 2012.

Credit reduction states

Employers that pay their state unemployment tax timely and in full receive a 5.4% credit. However, that credit is reduced when a state has outstanding federal loans for two consecutive Januarys. The reduction is 0.3% for the first year and an additional 0.3% for each succeeding year until the loan is repaid. A state that has not repaid the money it has borrowed is called a credit reduction state.

The 0.3% credit reduction states for 2011 (for taxes paid in 2012) are Arkansas, California, Connecticut, Florida, Georgia, Illinois, Kentucky, Minnesota, Missouri, Nevada, New Jersey, New York, North Carolina, Ohio, Pennsylvania, Rhode Island, Virginia and Wisconsin, plus the U.S. Virgin Islands. Indiana is a 0.6% credit reduction state and Michigan is a 0.9% credit reduction state. South Carolina has received conditional approval for the full FUTA credit.

Taxable Wage Bases for 2012
State — 2012 Wage Base
Alabama — 8,000
Alaska — 35,800
Arizona — 7,000
Arkansas — 12,000
California — 7,000
Colorado — 11,000
Connecticut — 15,000
Delaware — 10,500
District of Columbia — 9,000
Florida — 8,500
Georgia — 8,500
Hawaii — 38,800
Idaho — 34,100
Illinois — 13,560
Indiana — 9,500
Iowa — 25,300
Kansas — 8,000
Kentucky — 9,000
Louisiana — 7,700
Maine — 12,000
Maryland — 8,500
Massachusetts — 14,000
Michigan — 9,500
Minnesota — 28,000
Mississippi — 14,000
Missouri — 13,000
Montana — 27,000
Nebraska — 9,000
Nevada — 26,400
New Hampshire — 14,000
New Jersey — 30,300
New Mexico — 22,400
New York — 8,500
North Carolina — 20,400
North Dakota — 27,900
Ohio — 9,000
Oklahoma — 19,100
Oregon — 33,000
Pennsylvania — 8,000
Puerto Rico — 7,000
Rhode Island — 19,600*
South Carolina — 12,000
South Dakota — 12,000
Tennessee — 9,000
Texas — 9,000
Utah — 29,500
Vermont — 16,000
Virgin Islands — 23,700
Virginia — 8,000
Washington — 38,200
West Virginia — 12,000
Wisconsin — 13,000
Wyoming — 23,000

* Rhode Island has a two-tier taxable wage base for 2012. For most employers it will be $19,600. For those in the highest tax group (9.79%), the taxable wage base will be $21,100.

IRS Issues Regs On Exclusion For Injury/Sickness Damages

2012-02-01T11:09:00.002-06:00

The IRS has released final regulations relating to the exclusion from gross income for amounts received on account of personal physical injuries or physical sickness. The final regulations reflect amendments made by the Small Business Job Protection Act of 1996 (P.L. 104-188) and affect taxpayers receiving damages on account of personal physical injuries or physical sickness and taxpayers paying these damages.

The final regulations adopt without substantive change proposed regulations (NPRM REG-127270-06) issued on September 15, 2009. The proposed regulations deleted the requirement that, to qualify for exclusion from gross income, damages received from a legal suit, action, or settlement agreement must be based upon "tort or tort type rights." The proposed regulations provided, instead, that the Code Sec. 104(a)(2) exclusion may apply to damages recovered for a personal physical injury or physical sickness under a statute that does not provide for a broad range of remedies, and that the injury need not be defined as a tort. These regulations are effective January 23, 2012, and apply to damages paid pursuant to a written binding agreement, court decree, or mediation award entered into or issued after September 13, 1995, and received after January 23, 2012. (T.D. 9573, January 20, 2012.)

Identity Theft Crackdown Sweeps Across the Nation; More than 200 Actions Taken in Past Week in 23 States

2012-01-31T14:25:00.000-06:00

WASHINGTON – The Internal Revenue Service and the Justice Department today announced the results of a massive national sweep cracking down on suspected identity theft perpetrators as part of a stepped-up effort against refund fraud and identity theft.

Working with the Justice Department’s Tax Division and local U.S. Attorneys’ offices, the nationwide effort targeted 105 people in 23 states. The coast-to-coast effort took place over the last week and included indictments, arrests and the execution of search warrants involving the potential theft of thousands of identities and taxpayer refunds. In all, 939 criminal charges are included in the 69 indictments and informations related to identity theft.

In addition, IRS auditors and investigators conducted extensive compliance visits to money service businesses in nine locations across the country in the past week. The approximately 150 visits occurred to help ensure these check-cashing facilities aren’t facilitating refund fraud and identity theft.

“This unprecedented effort against identity theft sends a strong, unmistakable message to anyone considering participating in a refund fraud scheme this tax season,” said IRS Commissioner Doug Shulman. “We are aggressively pursuing cases across the nation with the Justice Department, and people will be going to jail. This is part of a much wider effort underway at the IRS to help protect taxpayers.”

“The Justice Department is working closely with the IRS to investigate, prosecute, and punish tax refund crimes committed through the theft of identities,” said Principal Deputy Assistant Attorney General John A. DiCicco of the Tax Division. “Now, more than ever, we must remain vigilant against the unauthorized use of identification information to defraud the U.S. government.”

The national effort is part of a comprehensive identity theft strategy the IRS has embarked on that is focused on preventing, detecting and resolving identity theft cases as soon as possible. In addition to the law-enforcement crackdown, the IRS has stepped up its internal reviews to spot false tax returns before tax refunds are issued as well as working to help victims of the identity theft refund schemes.

The law-enforcement sweep started last week across the country, reflecting investigative efforts stretching back months and even years.

The nationwide effort by the Justice Department and the IRS led to actions taking place in 23 locations across the country with 105 individuals. The actions included 80 complaints/indictments and informations, 58 arrests, 19 search warrants, 10 guilty pleas and four sentencings. A map of the locations and additional details on the actions are available on IRS.gov, the IRS Civil and Criminal Actions page and the Department of Justice Tax Division page.

Beyond the criminal actions, the IRS enforcement personnel conducted a special sweep last week and on Monday to visit 150 money services businesses to help make sure these businesses are not knowingly or unknowingly facilitating identity theft or refund fraud. The visits occurred in nine high-risk places identified by the IRS covering areas in and surrounding Atlanta, Birmingham, Ala., Chicago, Los Angeles, Miami, New York, Phoenix, Tampa and Washington, D.C.

In addition, the IRS has more than 250 check-cashing operations under audit across the country and will be looking for indicators of identity theft as part of the exam effort.

The information from these audits and compliance visits will be used to assist continuing IRS investigations into refund fraud and identity theft.

The IRS also is taking a number of additional steps this tax season to prevent identity theft and detect refund fraud before it occurs. These efforts includes designing new identity theft screening filters that will improve the IRS’s ability to spot false returns before they are processed and before a refund is issued, as well as expanded efforts to place identity theft indicators on taxpayer accounts to track and manage identity theft incidents.

To help taxpayers, the IRS earlier this month created a new, special section on IRS.gov dedicated to identity theft matters, including YouTube videos, tips for taxpayers and a special guide to assistance. The information includes how to contact the IRS Identity Protection Specialized Unit and tips to protect against “phishing” schemes that can lead to identity theft.

Identity theft occurs when someone uses another’s personal information without their permission to commit fraud or other crimes using the victim’s name, Social Security number or other identifying information. When it comes to federal taxes, taxpayers may not be aware they have become victims of identity theft until they receive a letter from the IRS stating more than one tax return was filed with their information or that IRS records show wages from an employer the taxpayer has not worked for in the past.

If a taxpayer receives a notice from the IRS indicating identity theft, they should follow the instructions in that notice. A taxpayer who believes they are at risk of identity theft due to lost or stolen personal information should contact the IRS immediately so the agency can take action to secure their tax account. The taxpayer should contact the IRS Identity Protection Specialized Unit at 800-908-4490. The taxpayer will be asked to complete the IRS Identity Theft Affidavit, Form 14039, and follow the instructions on the back of the form based on their situation.

Taxpayers looking for additional information can consult the Taxpayer Guide to Identity Theft or the IRS Identity Theft Protection page on the IRS website.

IRS Provides 2012 Cents-Per-Mile, Fleet Valuations

2012-01-18T12:01:00.002-06:00

The IRS has released the maximum allowable value of certain employer-provided automobiles, including trucks and vans, that are first made available to employees for personal use during calendar year 2012. The maximum value of vehicles for which the cents-per-mile valuation rule of Reg. §1.61-21(e) may apply is $15,900 for a passenger automobile and $16,700 for a truck or van. The maximum value for vehicles for which the fleet-average valuation rule of Reg. §1.61-21(d) may apply is $21,100 for a passenger automobile and $21,900 for a truck or van. (Rev. Proc. 2012-13, I.R.B. 2012-3, January 17, 2012.)

IRS Releases 2012 Pub 15

2012-01-18T11:59:00.000-06:00

The IRS has released the 2012 Pub 15 (Circular E), Employer's Tax Guide.

Future developments. The IRS has created a page on IRS.gov for information about Publication 15 (Circular E) at www.irs.gov/pub15. Information about any future developments affecting Publication 15 (Circular E) (such as legislation enacted after it is released) will be posted on that page.

Social security and Medicare tax for 2012. The employee tax rate for social security is 4.2% on wages paid and tips received before March 1, 2012. The employee tax rate for social security increases to 6.2% on wages paid and tips received after February 29, 2012. The employer tax rate for social security remains unchanged at 6.2%. The social security wage base limit is $110,100. The Medicare tax rate is 1.45% each for the employee and employer, unchanged from 2011. There is no wage base limit for Medicare tax. Employers should implement the 4.2% employee social security tax rate as soon as possible, but not later than January 10.

January 31, 2012. After implementing the 4.2% rate, employers should make an offsetting adjustment in a subsequent pay period to correct any overwithholding of social security tax as soon as possible, but not later than March 31, 2012. Social security and Medicare taxes apply to the wages of household workers you pay $1,800 or more in cash or an equivalent form of compensation. Medicare taxes apply to election workers who are paid $1,500 or more in cash or an equivalent form of compensation.

At the time this publication was prepared for release, the rate for the employee's share of social security tax was 4.2% and scheduled to increase to 6.2% for wages paid after February 29, 2012. However, Congress is discussing an extension of the 4.2% employee tax rate for social security beyond February 29, 2012.

VOW to Hire Heroes Act of 2011. On November 21, 2011, the President signed into law the Veterans Opportunity to Work (VOW) to Hire Heroes Act of 2011. This new law provides an expanded work opportunity tax credit to businesses that hire eligible unemployed veterans and, for the first time, also makes part of the credit available to tax-exempt organizations. Businesses claim the credit as part of the general business credit and tax-exempt organizations claim it against their payroll tax liability. The credit is available for eligible unemployed veterans who begin work on or after November 22, 2011, and before January 1, 2013. More information about the credit against a tax-exempt organization's payroll tax liability will be available early in 2012 at www.irs.gov/form5884c.

FUTA tax rate. The FUTA tax rate is 6.0% for 2012.

Expiration of Attributed Tip Income Program (ATIP). The Attributed Tip Income Program (ATIP) expired on December 31, 2011.

Change of address. Beginning in 2012, employers must use new Form 8822-B, Change of Address—Business, for any address change.

IRS e-file Launches Today; Most Taxpayers Can File Immediately

2012-01-17T16:09:00.000-06:00

WASHINGTON — The Internal Revenue Service opened the 2012 electronic tax return filing season today with a reminder to taxpayers that e-file remains the best way to get fast refunds and ensure accurate tax returns.

IRS e-file has surpassed the milestone of 1 billion returns processed. The electronic transmission system revolutionized the way the IRS processes tax returns and made speedy refunds possible. More than 112 million income tax returns were e-filed last year, or 77 percent of all individual returns filed.

"E-file is the best option for taxpayers. E-file enables taxpayers to file more accurate returns and receive their refunds quickly and safely," said IRS Commissioner Doug Shulman.

In general, for people concerned about security, e-file has proven itself year in and year out as a safe and secure method of filing a tax return. E-file has a proven track record. Software vendors and paid tax return preparers use the latest encryption technology. Plus, within 48 hours, an electronic acknowledgement is issued that the return has been received by the IRS and either accepted or rejected.
With most people receiving a refund, the fastest way to get a refund is by e-filing and using direct deposit. Taxpayers can get their money automatically in as few as 10 days. Last year, more than 79 million refunds were electronically deposited into taxpayers’ accounts, saving them a trip to the bank.

For people who owe taxes, e-file offers payment alternatives such as filing now and scheduling payment on the April tax deadline. Taxpayers who still want to pay by check can do so by e-filing and then mailing a payment voucher.

Taxpayers can e-file their tax returns one of three ways: through a tax return preparer, through self-preparation software or through IRS Free File. The IRS does not charge for e-file. Many tax return preparers and software products also offer free e-filing with their services. Free File offers free tax preparation and free electronic filing.

Starting this filing season, any paid preparer who prepares and files more than 10 returns for clients generally must file the returns electronically. Taxpayers are encouraged to use tax return preparers who offer IRS e-file.

Taxpayers should also only use paid preparers who sign the returns they prepare and enter their Preparer Tax Identification Numbers (PTINs). Preparers are required to sign the returns they prepare and include their PTINs. Although paid preparers sign returns, taxpayers are legally responsible for the accuracy of every item on their return. Preparers are also required to give taxpayers a copy of their returns.
When using e-file, you also use an e-signature and an electronic filing PIN. If you prepare your own return using software you must use the self-select PIN method on the return. When using a paid preparer, you can still use the self-select PIN method or the practitioner PIN method. The Electronic Filing PIN is a temporary PIN used by the IRS to verify your identity when you e-file.

IRS Free File, which has been making taxes a little less taxing for a decade, also begins today, Jan. 17. Everyone can use Free File, either the brand-name software offered by IRS’ commercial partners or the online fillable forms. Individuals or families with 2011 adjusted gross incomes of $57,000 or less can use Free File software. Free File Fillable Forms, the electronic version of IRS paper forms, has no income restrictions.

Top Tips Every Taxpayer Should Know about Identity Theft

2012-01-17T16:07:00.000-06:00

Identity theft often starts outside of the tax administration system when someone’s personal information is unfortunately stolen or lost. Identity thieves may then use a taxpayer’s identity to fraudulently file a tax return and claim a refund. In other cases, the identity thief uses the taxpayer’s personal information in order to get a job. The legitimate taxpayer may be unaware that anything has happened until they file their return later in the filing season and it is discovered that two returns have been filed using the same Social Security number.

Here are the top 13 things the IRS wants you to know about identity theft so you can avoid becoming the victim of an identity thief.

1. The IRS does not initiate contact with taxpayers by email to request personal or financial information. The IRS does not send emails stating you are being electronically audited or that you are getting a refund.

2. If you receive a scam e-mail claiming to be from the IRS, forward it to the IRS at phishing@irs.gov.

3. Identity thieves get your personal information by many different means, including:
* Stealing your wallet or purse
* Posing as someone who needs information about you through a phone call or
e-mail
* Looking through your trash for personal information
* Accessing information you provide to an unsecured Internet site.

4. If you discover a website that claims to be the IRS but does not begin with ‘www.irs.gov,’ forward that link to the IRS at phishing@irs.gov.

5. To learn how to identify a secure website, visit the Federal Trade Commission at www.onguardonline.gov/tools/recognize-secure-site-using-ssl.aspx.

6. If your Social Security number is stolen, another individual may use it to get a job. That person’s employer may report income earned by them to the IRS using your Social Security number, thus making it appear that you did not report all of your income on your tax return. When this occurs, you should contact the IRS to show that the income is not yours. Your record will be updated to reflect only your information. You will also be asked to submit substantiating documentation to authenticate yourself. That information will be used to minimize this occurrence in future years.

7. Your identity may have been stolen if a letter from the IRS indicates more than one tax return was filed for you or the letter states you received wages from an employer you don’t know. If you receive such a letter from the IRS, leading you to believe your identity has been stolen, respond immediately to the name, address or phone number on the IRS notice.

8. If your tax records are not currently affected by identity theft, but you believe you may be at risk due to a lost wallet, questionable credit card activity, or credit report, you need to provide the IRS with proof of your identity. You should submit a copy of your valid government-issued identification – such as a Social Security card, driver’s license, or passport – along with a copy of a police report and/or a completed IRS Form 14039, Identity Theft Affidavit, which should be faxed to the IRS at 978-684-4542. Please be sure to write clearly. As an option, you can also contact the IRS Identity Protection Specialized Unit, toll-free at 800-908-4490. You should also follow FTC guidance for reporting identity theft at www.ftc.gov/idtheft.

9. Show your Social Security card to your employer when you start a job or to your financial institution for tax reporting purposes. Do not routinely carry your card or other documents that display your Social Security number.

10. For more information about identity theft – including information about how to report identity theft, phishing and related fraudulent activity – visit the IRS Identity Theft and Your Tax Records Page, which you can find by searching “Identity Theft” on the IRS.gov home page.

11. IRS impersonation schemes flourish during tax season and can take the form of e-mail, phone websites, even tweets. Scammers may also use a phone or fax to reach their victims. If you receive a paper letter or notice via mail claiming to be the IRS but you suspect it is a scam, contact the IRS at http://www.irs.gov/contact/index.html to determine if it is a legitimate IRS notice or letter. If it is a legitimate IRS notice or letter, reply if needed. If the caller or party that sent the paper letter is not legitimate, contact the Treasury Inspector General for Tax Administration at 1-800-366-4484. You may also fax the notice/letter you received, plus any related or supporting information, to TIGTA. Note that this is not a toll-free FAX number 1-202-927-7018.

12. While preparing your tax return for electronic filing, make sure to use a strong password to protect the data file. Once your return has been e-filed, burn the file to a CD or flash drive and remove the personal information from your hard drive. Store the CD or flash drive in a safe place, such as a lock box or safe. If working with an accountant, you should ask them what measures they take to protect your information.

13. If you have information about the identity thief that impacted your personal information negatively, file an online complaint with the Internet Crime Complaint Center (IC3) at www.ic3.gov. The IC3 gives victims of cyber crime a convenient and easy-to-use reporting mechanism that alerts authorities of suspected criminal or civil violations. IC3 sends every complaint to one or more law enforcement or regulatory agencies that have jurisdiction over the matter.

Worker Misclassification Explained

2011-11-22T12:50:00.000-06:00

Introduction
The employment tax provisions of the Internal Revenue Code impose a number of obligations on employers with employees. Generally, an employer must withhold social security, Medicare and income taxes on wages paid to employees. In addition, an employer must pay its share of FICA taxes and pay federal unemployment tax (FUTA) based on wages paid to employees.

* An employee misclassified as an independent contractor raises several issues for an employer including:

* the employers liability for payroll taxes that should have been collected and/or paid;

* the availability of Act Sec. 530 relief;

* the employer's right to have the IRS's classification of an employee by the Tax Court;

* the employer's ability to participate in the IRS's Classification Settlement Program.

Effect of Worker Reclassification
Reclassification of a worker's status affects both the worker and the employer. A worker classified as an independent contractor is self-employed and, therefore, pays self-employment tax instead of FICA. An employer whose workers are reclassified as employees may owe both its share and its employees' share of FICA. Such a reclassification can create a large tax liability.

Worker Reclassification - Effect on Worker
When a worker who has been treated as self-employed is reclassified as an employee, he no longer pays self-employment tax. Instead, he pays social security and Medicare (FICA) taxes.

Employees who have been misclassified as independent contractors use Form 8919, Uncollected Social Security and Medicare Tax on Wages, to figure and report the employee's share of uncollected social security and Medicare taxes due on their compensation. Using Form 8919 allows the employee's social security and Medicare taxes to be credited to the employee's social security record. See Example Form 8919 below.

Comment
A worker who files Form 8919 loses the ability to deduct business expenses on Schedule C, since employee expenses are deductible only on Schedule A and are subject to the 2-percent floor for miscellaneous itemized deductions.

Worker Reclassification - Effect on Employer
It is important for an employer to properly classify a worker as an employee or an independent contractor. If an employer erroneously classifies an employee as an independent contractor, and has no reasonable basis for doing so, the employer is liable for employment taxes.

Comment
The individuals responsible for withholding and paying the taxes can be held personally liable for a penalty equal to the tax. This is called the trust fund recovery penalty. The determination may also affect any retirement or benefits plans maintained by the employer.

Because of the serious tax deficiencies that can arise when workers are misclassified, Code Sec. 3509 fixes an employer's liability for employment taxes at a fraction of the amount that should have been withheld. Thus, Code Sec. 3509 provides relief to employers who would otherwise be liable for the full amount of such taxes.

Employer Liability for Reclassified Workers' Taxes
If, during any calendar year, an employer fails to deduct and withhold income or FICA tax from an employee's wages by reason of treating the employee as a non-employee, the employer's liability for those taxes is generally calculated as follows:

* The employer's liability for an employee's income tax withholding is 1.5 percent of the wages paid to the employee for the year.

* The employer's liability for the employee's share of FICA taxes is 20 percent of the actual amount imposed under those provisions for the year (Code Sec. 3509(a)).

Under these rules, an employer has failed to deduct and withhold tax when it fails to pay the total tax required to be withheld during the calendar year by the due date of the employment tax return for the final quarter of that calendar year (Reg. Â§31.3509-1(b)(1)).

Exceptions to the Employer Liability Rules
An employer who fails to timely file any return or statement, such as a Form 1099-MISC, required for consistent treatment of the worker as a nonemployee must pay an increased amount, The employer's liability doubles to 3 percent for income tax withholding and 40 percent for FICA tax withholding (Code Sec. 3509(b)).

Further, no rate relief under Code Sec. 3509 applies at all when:

* the employer withheld income tax but not FICA tax, or

* the employer intentionally disregarded its obligation to deduct and withhold the tax.

An employer has intentionally disregarded the requirement to deduct and withhold a tax if it intentionally fails to deduct and withhold the full amount of the tax from an employee's wages paid after the employer ascertained the worker's status as an employee (Prop. Reg. Â§31.3509-1(d)(4)).

These employer liability rules do not apply to FICA tax for statutory employees. This exception applies even if the statutory employee is also an employee by reason of his status as a corporate officer or a common law employee (Code Sec, 3509(d)(3)).

Satisfying Employer Misclassification Liability
An employer's worker misclassification liability may not be collected from an employee and the employer may not offset the liability against any tax the employee has paid.

On the other hand, an employer's misclassification liability is satisfied to the extent that the employer actually withheld tax from the employee's wages and paid it to the IRS. However, if the amount withheld, deducted, and paid exceeds the employer's Code Sec. 3509 liability, the employer may not claim a refund or credit for the excess amount.

Comment
Code Sec. 3509 applies only to the employee's share of FICA. The employer remains liable for its share of FICA. Similarly, an employee's FICA and income tax liability is not affected by assessment or collection of any tax under Code Sec. 3509. In addition, any amount assessed or collected under Code Sec. 3509 is not credited against the employee's tax liability (Code Sec. 3509(d)(1); Prop. Reg. Â§31.3509-1(d)(1)).

Employers may use Code Section 3509 to calculate their liability when a worker reclassification results from an IRS enforcement action in an examination, or when the employer receives a determination letter from the IRS reclassifying a worker as an employee.

Act Sec. 530 Safe Harbor Relief from Liability
An employer may be relieved of misclassification liability if the employer had a reasonable basis for treating the worker as an independent contractor. Act Sec. 530 of the Revenue Act of 1978, as amended, is a safe harbor for employers that misclassify workers. For purposes of the employment tax provisions when:

* a taxpayer did not treat an individual as an employee for any period, and

* the taxpayer filed all required federal tax returns (including information returns) as if the individual were an independent contractor (Rev. Proc. 85-18), then the individual is treated as not being an employee for that period.

This exception does not apply if the employer had no reasonable basis for treating the individual as an independent contractor. In addition, the employer may continue to treat the individual as an independent contractor.

The IRS must provide the employer with written notice of Act Sec. 530 at the beginning of any worker classification audit.

Comment
The notice requirement is fulfilled by IRS Pub. 1976, Independent Contractor or Employee, if delivered to the employer by the agent when commencing the payroll audit.

Act Sec. 530 relief is available even if the worker is a common-law employee.

Act Sec. 530 relief does not apply to a three-party transaction in which the taxpayer arranges with a second party for a third party to provide the services as a technical service specialist.

A technical service specialist is an engineer, designer, drafter, computer programmer, systems analyst, or other similarly skilled worker engaged in a similar line of work (Notice 87-19). The worker status of a technical service specialist in such three-party arrangements is determined under common law principles. However, Act Sec. 530 relief applies when a taxpayer directly contracts with a worker to provide services for the taxpayer.

Reasonable Basis for Classifying Worker
To obtain Act Sec. 530 safe harbor relief, the business's basis for treating the worker as an independent contractor must be reasonable.

The IRS has identified three safe harbors that provide a reasonable basis under Act Sec. 530 for treating a worker as an independent contractor:

* judicial precedents or rulings,

* prior audit, and

* long standing recognized practice.

Practice Tip
If an employer relies on any of these safe harbors, it meets its burden of proof by simply establishing a prima facie case. The IRS bears the burden of proving the employer wrong as long as the employer cooperates with the IRS's investigation.

The IRS's position is that Act Sec. 530 relief is not available if the employer has not timely filed Forms 1099 for the workers involved (Internal Revenue Manual (IRM) 4.23.5.2.2.1(2)(A)).

In contrast, the Tax Court has held that Act Sec. 530 does not require timely filing; therefore, late filing of Forms 1099 would not preclude a taxpayer from qualifying for Act Sec. 530 relief (Medical Emergency Care Associates, S.C., Dec. 55,154, 120 TC 436).

Worker Misclassification Issues

2011-11-22T12:45:00.000-06:00

Question: Does a worker's reclassification affect an employer?

Answer: Reclassification of a worker's status affects both the worker and the employer. A worker classified as an independent contractor is self-employed and, therefore, pays self-employment tax instead of FICA. An employer whose workers are reclassified as employees may owe both its share and its employees' share of FICA. Such a reclassification can create a large tax liability.

Question: Is an employer penalized for failing to treat a worker consistently?

Answer: An employer who fails to timely file any return or statement, such as a Form 1099-Misc., required for consistent treatment of the worker as a nonemployee must pay an increased amount, The employer's liability doubles to 3 percent for income tax withholding and 40 percent for FICA tax withholding.

Question: May an employer collect tax due because of an employee's misclassification from the employee?

Answer: An employer's worker misclassification liability may not be collected from an employee and the employer may not offset the liability against any tax the employee has paid.

Consumer Prices Show Slight Drop In October

2011-11-22T12:44:00.000-06:00

Consumer prices as measured by the Urban Wage Earners and Clerical Workers index (CPI-W) declined 0.1 percent over the month, as seasonally adjusted, the Bureau of Labor Statistics reported on Wednesday, November 16. The CPI-W, which is used as an escalator in union contracts and in federal entitlement payments, registered an October level of 223.043 (1982-84=100), which was 3.9 percent higher than in October 2010, prior to seasonal adjustment. Consumer prices as measured by the All Urban Consumers index (CPI-U) also declined 0.1 percent on a seasonally adjusted basis; the October level of 226.421 (1982-84=100) was 3.5 percent higher than in October 2010 (unadjusted). Prior to seasonal adjustment, the CPI-W decreased 0.3 percent, and the CPI-U decreased 0.2 percent over the month (USDL 11-1644, Bureau of Labor Statistics).

Among the various components comprising the CPI-W as seasonally adjusted, Medical care registered the highest increase, up 0.5 percent, followed by Apparel and Education and communication, both up 0.2 percent. Food and beverages and Housing increased 0.1 percent. Transportation registered the largest decrease, down 1.2 percent. Other goods and services and Recreation were unchanged over the month.

Senate Approves Bill Repealing 3% Withholding, Tax Breaks For Vet Hires

2011-11-22T12:43:00.002-06:00

Senate lawmakers on November 10 voted 95 to 0 to approve legislation (HR 674) repealing the 3% withholding tax imposed on federal contractors. The measure includes a Democratic amendment, the VOW to Hire Heroes Bill, which provides tax credits for employers who hire military veterans and increases existing tax credits for companies that hire veterans with service-connected disabilities.

The Joint Committee on Taxation estimated the withholding tax repeal would cost $11.2 billion over 10 years, with the cost offset by changing the calculation of modified adjusted gross income in determining eligibility for some health care credits, including Medicaid, and the Children's Health Insurance Program. The 3% withholding tax was imposed six years ago on federal contractors to crack down on tax avoidance as part of the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222).

The VOW to Hire Heroes Bill of 2011 offers a tax credit of up to $5,600 for hiring veterans who have been looking for a job for more than six months, as well as a $2,400 credit for veterans who are unemployed for more than four weeks, but less than six months. In addition, the measure calls for a tax credit of up to $9,600 for hiring veterans with service-connected disabilities who have been looking for a job for more than six months. It also provides expanded training and education opportunities for all veterans. The $1.6-billion cost of the legislation is offset by delaying scheduled fee reductions on mortgage applications for loans guaranteed by the Department of Veterans Affairs.

The veterans measure is the first portion of President Obama's failed jobs package, the American Jobs Bill, to receive full bipartisan support in the Senate. The House approved repeal of the 3% withholding tax measure by a 405-to-16 vote on October 27, but Senate changes and addition of the VOW to Hire Heroes Bill will require House lawmakers to hold a vote on the revised legislation if the measure is to advance to the president's desk.

President Obama, in a written statement, said "Republicans and Democrats in the Senate did the right thing and passed tax credits that will encourage businesses to hire America's veterans." The president urged the House to pass the bill so he can sign it into law and to pass additional jobs proposals in the weeks ahead.

U.S. House Committee Passes Bill To Limit Taxation Of Mobile Workers' Income

2011-11-22T12:42:00.005-06:00

The U.S. House Judiciary Committee reported favorably legislation under which an employee's wages would not be subject to personal income tax or withholding and reporting requirements in any state other than the employee's state of residence and a state in which the employee is present and performing employment duties for more than 30 days during a calendar year. The Mobile Workforce State Income Tax Simplification Act (H.R. 1864) was introduced by Rep. Howard Coble, R-N.C., and Rep. Henry Johnson, D-Ga., on May 12, 2011. It would not apply to professional athletes, professional entertainers, and certain public figures. It would be effective January 1 of the second year after the date of enactment. The legislation, which was passed with technical corrections, now is available for consideration by the full U.S. House of Representatives.

IRS Requests Comments On Form 1099-SA

2011-11-22T12:42:00.002-06:00

The IRS is soliciting comments concerning Form 1099-SA, Distributions From an HSA, Archer MSA or Medical Advantage MSA. This form is used to report distributions from a medical savings account as required by Internal Revenue Code section 220(h).

Written comments should be received on or before January 17, 2012 to be assured of consideration and should be directed to Yvette Lawrence, Internal Revenue Service, room 6129, 1111 Constitution Avenue NW., Washington, DC 20224. (76 FR 71622, November 18, 2011.)

Tax Professionals Urged to Prepare for New e-File Rules

2011-11-21T14:40:00.003-06:00

The IRS has advised tax professionals and tax firms to start the process to obtain Electronic Filing Identification Numbers (EFINs), so they can meet new e-file requirements beginning in January 2012, if they are required to, but do not already have, EFINs (IRS News Release IR-2011-100). The requirement applies to any paid preparer or firm that reasonably anticipates preparing and filing 11 or more Form 1040 series returns, Form 1041 returns, or a combination of Form 1040 series returns and Form 1041 returns.

To become Authorized IRS e-file Providers, preparers must: (1) create an e-Services account; (2) submit an EFIN application; and (3) pass a suitability check. The approval process can take 45 days or more. For a firm or an individual, only one EFIN is needed. The 2012 requirement marks the second and final phase of implementing a law that was intended to boost the electronic filing rate of income tax returns for individuals, trusts and estates. In 2011, the e-file mandate pertained to any paid preparer or firm that anticipated preparing and filing 100 or more returns.

Preparers can review the process on the IRS's website at "Become an Authorized e-file Provider" or find additional guidance at the "Frequently Asked Questions" section. A one-year waiver, made by submitting Form 8944, Preparer e-file Hardship Waiver Request, may be requested if the e-file requirement will cause undue hardship. Form 8948, Preparer Explanation for Not Filing Electronically, should be included if a client wants to file a paper return.

Form 8948 should be obtained and kept with the preparer's records. It does not have to be submitted with returns that are not currently accepted electronically by the IRS or the IRS has instructed taxpayers not to file them electronically. These returns are exempt from the federal e-file requirement.

Reference: PTE §41,805

Supreme Court Agrees to Hear Challenge to Patient Protection Act

2011-11-21T14:40:00.000-06:00

The U.S. Supreme Court has granted certiorari in the case of State of Florida v. Department of Health and Human Services, CA-11, 2011-2 USTC ¶50,573. One of the questions that the Supreme Court has agreed to review is whether the suit challenging the minimum coverage provision of the Patient Protection and Affordable Care Act (Patient Protection Act) (P.L. 111-148) is barred by Code Sec. 7421(a). Another is whether the individual mandate provision of the Patient Protection Act, requiring individuals to purchase health insurance, is constitutional.

The Eleventh Circuit held that the mandate is not constitutional, as it is a regulatory penalty, not a revenue-raising tax, and so was beyond Congress's powers under the Taxing and Spending Clause. Further, the mandate went beyond Congress's powers under the Commerce Clause. However, the mandate is a severable provision, and its excision, therefore, did not invalidate the other provisions of the Patient Protection Act.

To date, four federal appeals courts have ruled on the constitutionality of the Patient Protection Act, reaching different results. Most recently, the U.S. Court of Appeals for the District of Columbia held that the Patient Protection Act's individual mandate was constitutional (Seven-Sky v. Holder, CA-D.C., 2011-1 USTC ¶50,713).

Reference: PTE §42,001

IRS Revises PTIN Rules For Enrolled Retirement Plan Agents

2011-11-21T14:39:00.005-06:00

Individuals do not need a preparer tax identification number (PTIN) when they apply to be an enrolled retirement plan agent (ERPA) or when they seek to renew the designation, the IRS has announced (Notice 2011-91, 2011-47 IRB).

An ERPA is an individual who has been approved by the IRS to practice before the agency on certain retirement plan issues. An ERPA may represent taxpayers before the IRS on matters involving the Employee Plans (EP) Determination Letter program; the EP Compliance Resolution System, the EP Master and Prototype Program and Volume Submitter Program; and Form 5300 and Form 5500 filings (but not with respect to actuarial forms or schedules).

Currently, Circular 230 requires ERPA candidates to have a valid PTIN. Circular 230 also requires individuals to have a PTIN to renew their ERPA designation.

As the result of a change in policy, effective immediately, the IRS is discontinuing the requirement that ERPA candidates and individuals renewing their ERPA status have a valid PTIN. However, an ERPA must have a PTIN if he or she prepares or assist in the preparation of any return not exempt from the PTIN requirement under Notice 2011-6, 2011-3 IRB 315, or future guidance. The IRS reported that it will revise Circular 230 to reflect the change.

Reference: PTE §39,010.20

IRS Updates FAQs on Registered Tax Return Preparer Exam, Plans November Launch

2011-11-21T14:39:00.002-06:00

The IRS has updated its online frequently asked questions (FAQs) on the registered tax return preparer exam. Preparers who are not certified public accountants (CPAs), enrolled agents (EAs), attorneys, supervised preparers, and non-series 1040 preparers must successfully pass the registered tax return preparer exam to prepare returns for compensation.

The IRS announced that the exam is expected to be available in late November 2011. The exam consists of 120 multiple choice and true/false questions and is timed at 21/2 hours.

The IRS also advised that the exam will be offered at designated testing locations. Candidates should bring an unexpired government-issued photo ID to the testing center.

Reference: PTE §41,401

IRS Moves to Slow Growth of Tax-Related Identity Theft

2011-11-21T14:38:00.003-06:00

The IRS intends to take additional measures to combat identity theft during the 2012 filing season, Steven Miller, Deputy Commissioner for Services and Enforcement, recently told Congress. Miller was joined by J. Russell George, Treasury Inspector General for Tax Administration, who reported that tax-related identity theft has grown significantly since 2008. Miller and George testified before the House Committee on Oversight and Government Reform, Subcommittee on Government Organization, Efficiency and Financial Management, on November 4, 2011.

Comment
Tax-related identity theft is a growing problem. George told lawmakers that IRS incident tracking reports indicated that 254,079 taxpayers were affected by identity theft in calendar year 2008. "As of August 31, 2011, IRS incident tracking reports indicated that 582,736 taxpayers were affected by identity theft in calendar year 2011," George said. "In calendar year 2011 to date, the IRS has protected $1.3 billion in refunds from being erroneously sent to identity thieves," Miller added.

George explained that there are two types of identity theft that relate to tax administration: tax fraud identity theft and employment identity theft. In tax fraud identity theft cases, an individual uses another person's name and/or Social Security number (SSN) to file a fraudulent tax return, which results in a refund. In employment identity theft cases, an individual uses another person's identity to obtain employment.

"Employment identity theft can affect taxpayers when the IRS attempts to take enforcement actions for what appears to be unreported income," George explained. "Refund fraud using another person's identity has a more substantial effect. After an identity thief has successfully committed the crime and is enjoying the benefits, the victim begins to realize the harm. It affects lawful taxpayers' ability to file their returns and can delay their tax refunds."

"The majority of identity theft cases are worked by telephone assistors," George said. "Total time spent on a case can vary significantly and sometimes cases can stay open for months with little or no activity as assistors answer calls or work other types of cases." Miller told lawmakers that the IRS has "redoubled its training efforts" for assistors.

In 2011, the IRS began issuing Identity Protection Personal Identification Numbers (IP PINs) to victims of identity theft under a pilot program. "The IP PIN will indicate that the taxpayer has previously provided the IRS with information that validates his or her identity and that the IRS is satisfied that the taxpayer is a valid holder of the SSN," George said. "Under this pilot, the IRS issued IP PINs to over 50,000 taxpayers who were identity theft victims," Miller added.

Miller said that the IRS will expand the IP PIN program for the 2012 filing season. "The IRS will be issuing IP PINs to more than 200,000 taxpayers who have suffered identity theft in the past," Miller explained.

The IRS is also taking steps to stop the growing trend of fraudulent tax returns being filed under deceased taxpayers' identities, Miller said. The IRS intends to expand a pilot program that marks the accounts of deceased taxpayers to prevent misuse by identity thieves. "The IRS has marked 230,000 accounts of decedents. This will be an ongoing process," Miller reported.

The recently enacted U.S.-Korea trade agreement requires federal and state prisons to provide information on the current prison population to the IRS, including the names and last known addresses of inmates, to curb fraudulent filings by inmates. "The IRS intends to engage with prison officials to determine the best way to move forward with this new authority," Miller said.

IRS to Delay Fingerprinting Requirement for Certain PTIN Applicants

2011-11-21T14:38:00.000-06:00

IRS Commissioner Douglas H. Shulman told tax professionals on November 8 that the IRS has delayed its plan to fingerprint certain preparers who apply for preparer tax identification numbers (PTIN) (IRS News Release IR-2011-108). Shulman spoke at the national tax conference of the American Institute of Certified Public Accountants (AICPA) in Washington, D.C.

Effective January 1, 2011, all return preparers who prepare returns for compensation, subject to certain exceptions, must obtain or renew a PTIN. The IRS launched an online PTIN registration system in 2010. "Sixty percent of the preparers who have registered for a PTIN are not CPAs, enrolled agents or attorneys," Shulman reported. The IRS has also posted PTIN troubling-shooting tips on its website.

The IRS indicated that certain preparers would be required to submit their fingerprints when applying for a PTIN. At an October 7 hearing, the AICPA and other professional organizations asked the IRS to revisit the fingerprinting proposal.

Shulman announced that the IRS has delayed the fingerprinting proposal. "We have decided to hold off on fingerprinting as we consider the issues that have been raised, and have further discussions with interested parties," Shulman said.

Comment
"The AICPA welcomes the development," Edward Karl, CPA, vice president, taxation, AICPA, said. "The IRS heard a chorus of concern about the proposal on October 7," Karl added.

Individuals who are not CPAs, EAs [enrolled agents], attorneys and certain other preparers are exempt at this time from the registered tax return preparer examination. "From the beginning, we planned to exempt CPAs, EAs and attorneys from the testing requirements," Shulman said. He noted that the CPA community has extensive testing and continuing education requirements in place. On its website, the IRS reported that the registered tax return preparer examination is expected to be available in late November.

"Beginning soon, the IRS will send letters to tax return preparers who have been identified as high risk," Shulman said. "The letters are not sent randomly. They are based on real data where we see compliance issues." The IRS also will increase in-person visits to preparers. Additionally, the IRS will beef up the resources available to the IRS Office of Professional Responsibility (OPR).

Reference: PTE §41,515.05

Estate Entitled to Deduct Interest Expense for Loan to Pay Estate Tax

2011-11-21T14:37:00.000-06:00

An estate was entitled to deduct its interest expense because the loan was actually and reasonably necessary to the administration of the estate, the Tax Court has held (Estate of Duncan v. Commissioner, Dec. 58,797(M), TC Memo. 255).

After inheriting an interest in his grandfather's oil and gas business, the decedent started his own oil and gas company. He eventually transferred the company, along with his interest in a ski resort and several other assets, to a revocable trust (Trust 1).

Pursuant to the terms of Trust 1, after the decedent's death, the trust was to pay the estate's obligations and taxes before being divided into separate trusts for the benefit of the decedent's children. Following the decedent's death, the trust sold all of its liquid assets; however, after the sale, it still needed an additional $6 million to pay the estimated estate tax.

In order to avoid selling illiquid assets, the trust borrowed the necessary funds from a separate trust (Trust 2) over which the decedent held a general power of appointment. Because of the difficulty of predicting the income stream from an oil and gas business, the trusts agreed on a 15-year bullet loan with an interest rate of 6.7 percent, which was set by a corporate fiduciary's banking department and was 1.55 percent below prime.

The estate's loan was bona fide because there was a genuine intention to create a debt with a reasonable expectation of repayment, the court ruled. According to the IRS, the loan had no economic consequence because the borrower and the creditor trusts were identical.

Although both trusts had the same trustees and beneficiaries, the court noted that it was not possible to combine the trusts into a single entity or to comingle their assets. The trusts had different terms and different grantors. Combining the trusts would have been a violation of applicable state law, and there was no basis for combining or commingling the trusts under federal estate tax law.

Furthermore, the court determined that the loan was necessary to pay the estate tax and the terms of the loan were reasonable. The court noted that, if Trust 1 was to sell its illiquid assets, it would have had to do so at a discount, even if it had sold the assets to Trust 2. Although Trust 1 had enough revenue after three years to repay the loan, the court found that the terms of the loan were reasonable because the volatility of oil and gas prices made future income difficult to predict. In addition, the interest rate was not excessive, as it was based on the market rate for a loan with similar characteristics. Finally, in accordance with Reg. §20.2053-1(b)(3), the amount of the interest expense was ascertainable with reasonable certainty.

The loan was a bullet loan that prohibited prepayment. The trustees of Trust 2 could not permit prepayment because it would reduce Trust 2's interest income. Consequently, the court concluded that the estate was entitled to deduct the interest expense.

The Tax Court further held that the estate was not entitled to deduct expenses incurred in preserving and distributing the estate because the expenses were not necessary to the administration of the estate. Trust management fees were also not deductible because they were not, as claimed, compensation for executor services. However, the court found that additional attorney's fees were deductible and were not computed under Rule 155 because the reasonableness of attorney's fees was a legal issue.

Reference: PTE §34,305.15

Tax Court Includes Property in FLP in Decedent's Gross Estate

2011-11-21T14:36:00.002-06:00

The Tax Court has held that a decedent's transfer of real estate to a family limited partnership (FLP) was not a bona fide sale (Estate of Liljestrand v. Commissioner, Dec. 58,801(M), TC Memo. 2011-259). Therefore, the value of the property transferred to the FLP was included in the decedent's estate.

Comment
The Tax Court has ruled on this issue before, such as in Estate of Strangi v. Commissioner, Dec. 55,160(M), TC Memo. 2003-145, where the transferred property was included. Among other factors similar to this case, the decedent was found to have retained enjoyment of the property where he had used partnership funds to pay for his personal needs.

The decedent transferred more than $5 million in real estate to the FLP in exchange for a 98.8-percent limited partner interest. No other parties contributed to the FLP. Starting two years later, the FLP began paying the decedent's personal expenses along with gifts to his grandchildren. The FLP sold some of its real estate holdings to pay these personal expenses.

After the decedent's death in 2004, the IRS issued a notice of deficiency in the amount of $2.5 million. The IRS included the value of the real estate transferred to the FLP in the decedent's gross estate. The estate challenged the IRS's determination in the Tax Court.

The court rejected the estate's arguments in favor of exclusion of the transferred property, holding that it met all three conditions under which the value of the transferred property must be included in the gross estate under Code Sec. 2036(a): (1) the decedent made an inter vivos transfer of property; (2) the decedent's transfer was not a bona fide sale for adequate and full consideration; and (3) the decedent retained an interest in the transferred property, which he did not relinquish before his death.

The court further found the decedent did not have a legitimate non-tax reason for creating the FLP. The transaction lacked any arm's length bargaining before the formation of the partnership. Rather, the decedent "stood on all sides of the transaction," the court found. The FLP also failed to follow the most basic of partnership formalities, the court noted. The court was also not persuaded that the decedent had created the FLP to protect the real estate from potential creditors.

Additionally, the court noted that the decedent had retained the possession and enjoyment of the income from the transferred property. The decedent lacked sufficient funds outside the FLP to pay his personal expenses, including future obligations such as federal and state estate tax. Distributions were heavily weighted in the decedent's favor, the court observed.

Reference: PTE §34,125.20

IRS Allows Taxpayer-Friendly Treatment for Deduction of Employee Bonuses

2011-11-21T14:35:00.000-06:00

The IRS has determined that an employer using an accrual method of accounting can establish "fact of the liability" under the first-prong of Code Sec. 461's all-events test for bonuses payable to a group of employees, even though the employer would not know the identity of any specific recipient and the exact amount payable to that recipient until after the end of the tax year (Rev. Rul. 2011-29, 2011-49 IRB)

Comment
"Rev. Rul. 2011-29 is welcome guidance from the IRS and resolves some recent uncertainty on the issue. The ruling makes clear that a company that is obligated at the end of its tax year to pay a minimum bonus pool amount in the next year can meet the â€˜all events test' and deduct the amount for its current tax year," John McGuiness, principal, The Groom Law Group, Chartered, Washington, D.C., said. "This is true even though, as is often the case, the identity of the specific employees who will share in the bonus pool in the next year are not known at the end of the company's current year."

The taxpayer maintained an employee bonus program. Bonuses were calculated either through a formula or through other corporate action. Bonuses would be paid after the end of the tax year in which the employee performed services but before the 15th day of the third calendar month after the close of that tax year.

An employee must be employed by the company on the date the bonuses are paid to receive a bonus. Any bonus amount allocable to an employee who is not employed when the bonuses are paid is reallocated among other eligible employees.

Generally, Code Sec. 461(a) provides that the amount of any deduction or credit must be taken for the tax year that is the proper tax year under the method of accounting the taxpayer uses to compute taxable income. Reg. §1.461-1(a)(2)(i) further provides that, under an accrual method of accounting, a liability is incurred, and is generally taken into account for federal income tax purposes, in the tax year in which:

* All the events have occurred that establish the fact of the liability;

* The amount of the liability can be determined with reasonable accuracy; and

* Economic performance has occurred for the liability.

In Rev. Rul. 55-446, 1955-2 CB 531, the IRS had determined that bonuses payable under an incentive compensation plan, the exact amounts of which cannot be determined and paid by an accrual basis taxpayer until early in the following year, would properly be accruable and deductible for the year to which they relate, provided the total bonuses are definitely determinable through a formula in effect prior to the end of the tax year.

Comment
Rev. Rul. 61-127, 1961-2 CB 36, removed a notice requirement described in Rev. Rul. 55-446.

In Washington Post Co. v. United States, CtCls, 69-1 USTC ¶9192, the United States Court of Claims (the forerunner to today's Court of Federal Claims) found that a taxpayer incurred a liability to pay bonuses under a plan maintained for the benefit of certain employees as a group. Under the plan, if an employee did not meet certain specified conditions, a portion of the employee's share would be forfeited and reallocated to other dealers. The IRS declined to follow Washington Post in Rev. Rul. 76-345, 1976-2 CB 134.

The IRS determined, citing Rev. Rul. 55-446, the fact of the employer's liability for the minimum amount of bonuses would be established by the end of the year in which the services are rendered. The IRS noted that the employer would not know the identity of the ultimate recipients and the amount, if any, each employee would receive prior to the end of the tax year. However, these factors did not alter the outcome. Therefore, all the events have occurred by the end of the tax year that establish the employer's liability to pay the minimum amount of bonuses for purposes of the first-prong of the all-events test under Reg. §1.461-1(a)(2)(i), the IRS concluded.

Comment
The Supreme Court allowed a taxpayer to deduct amounts guaranteed for payment of progressive jackpots that had not yet been won in United States v. Hughes Properties, Inc., S.Ct., 86-1 USTC ¶9440. According to the Supreme Court, identification of the eventual recipients of the jackpots was inconsequential.

The IRS also advised that any change in a taxpayer's treatment of bonuses to conform with Rev. Rul. 2011-29 would be a change in method of accounting (to be made under Code Secs. 446 and 481). Additionally, the IRS revoked Rev. Rul. 76-345.

Reference: PTE §38,430.05

Modification of Installment Sale Was Not a Disposition

2011-11-21T14:33:00.002-06:00

The IRS has determined in a private letter ruling that modification of a stock purchase agreement and promissory note would not constitute a disposition of an installment obligation under Code Sec. 453B (IRS Letter Ruling 201144005). Therefore, the seller did not need to recognize gain or loss at that time.

Comment
An installment sale is a sale of property at a gain where at least one payment is to be received after the tax year in which the sale occurs. Under the installment method, taxpayers include in income each year only part of the gain the taxpayer receives, or is considered to have received. Code Sec. 453B provides that, if an installment obligation is satisfied at its face value or if it is distributed, transmitted, sold, or otherwise disposed of, the seller must recognize gain or loss at that time.

The taxpayer was the sole shareholder of a corporation. The taxpayer and five employees entered into stock purchase agreements and executed promissory notes to purchase shares in the corporation owned by the taxpayer.

Comment
The taxpayer undertook the sale as part of her business succession planning.

The employees agreed to make nine equal payments of principal and interest on the outstanding balance. The employees intended to use the corporation's annual distributions to make the payments. However, the economic downturn in recent years prevented the employees from making any payments beyond their initial payments. The employees proposed to reduce the purchase price and interest rate.

Several rulings, the IRS noted, have reviewed whether a modification of an installment obligation amounts to a disposition of the obligation. In Rev. Rul. 68-419, 1968-2 CB 196, the buyer purchased stock with a note providing for five equal annual payments. The buyer encountered financial difficulties and asked the seller to modify the note by deferring each payment for five years. The seller agreed and, in return, the buyer agreed to increase the interest rate. The IRS determined that these modifications of the note were not to be considered a disposition of an installment obligation.

In Rev. Rul. 74-157, 1974-1 CB 115, the taxpayer sold a parcel of land for cash and a promissory note secured by a deed of trust on the land. Because the purchaser wanted to divide the property into two parcels, the seller agreed to accept substitution of two promissory notes, each secured by a deed of trust on a parcel of land for the original unpaid note and deed. The revenue ruling holds that the substitution of the deeds and notes were not a disposition of an installment obligation.

The IRS subsequently held in Rev. Rul. 74-457, 1974-2 CB 122, that the substitution of obligors, deeds of trust, and promissory notes, without any other changes, would not constitute a disposition of an installment obligation. In Rev. Rul. 82-122, 1982-1 CB 80, the IRS further provided that substitution of a new obligor and a change in the rate of interest was not a disposition of an installment obligation.

Here, the IRS determined that the modification of payment terms between the taxpayer and the employees would not constitute a disposition of the installment agreement. The payment terms identified by the IRS included deferring/increasing payment dates, which were modifications similar to the modifications in the earlier rulings, such as Rev. Rul. 82-122. The IRS further determined that, where the original installment note is replaced, the substitution of a new promissory note without any other changes is not sufficient for the original note to be treated as "disposed of."

Reference: PTE §18,370

IRS Acquiesces in Gender Identity Disorder Case

2011-11-21T14:32:00.005-06:00

The IRS has announced its acquiescence in O'Donnabhain v. Commissioner, Dec. 58,122, 134 TC No. 4, where the Tax Court found that expenses for gender identity disorder surgery were deductible under Code Sec. 213 (AOD-2011-03, 2011-47 IRB).

The taxpayer was diagnosed with gender identity disorder and underwent sex reassignment surgery. On her return, the taxpayer claimed a medical expense deduction for the surgery and related expenses. The IRS disallowed the deduction, based on CCA 200603025. According to the IRS, the surgery did not treat a recognized disease or promote the proper function of the body.

O'Donnabhain was a case of first impression before the Tax Court. The court held that the taxpayer's gender identity disorder (GID) was a disease within the meaning of Code Sec. 213(d)(1)(A) and (9)(B) and, therefore, the cost of her hormone therapy and sex-reassignment surgery were deductible medical expenses under Code Sec. 213(a). However, the cost of the taxpayer's breast augmentation surgery was not deductible because it met the definition of cosmetic surgery under Code Sec. 213(d)(9)(B).

The Tax Court held that the taxpayer's GID was a disease for purposes of Code Sec. 213 in view of its widely recognized status in diagnostic and psychiatric reference texts as a legitimate diagnosis, the seriousness of the condition, the severity of the taxpayer's impairment as found by the mental health professionals who examined her, and the consensus in the U.S. Courts of Appeal that GID constitutes a serious medical need for purposes of the Eighth Amendment.

The government's argument that GID is a mental disorder but not a disease, for purposes of Code Sec. 213 because it does not have a demonstrated organic or physiological origin, was rejected. The court stated that the government's use of its expert's testimony to establish the meaning of "disease," a statutory term, was improper.

The IRS will no longer take the position reflected in CCA 200603025. The IRS explained it will follow the Tax Court's decision in O'Donnabhain.

"The IRS has now made clear that its previous position, as embodied in the 2006 Chief Counsel Advice, was wrong," Gay & Lesbian Advocates & Defenders Senior Staff Attorney Karen Loewy, who was the lead attorney on the O'Donnabhain case, said. "Going forward, the IRS will treat gender identity disorder as a legitimate medical condition, and expenses incurred for its treatment - including those related to hormone therapy and sex reassignment surgeries - will be considered deductible like those for every other medical condition. "

Reference: PTE §7,275

IRS Updates North American Area for Deducting Convention Expenses

2011-11-21T14:32:00.004-06:00

The IRS has updated the "North American area" for purposes of the Code Sec. 274(h) limitation on deducting convention expenses (Rev. Rul. 2011-26, 2011-48 IRB). The latest update includes the Republic of Panama within the North American area and transition relief for the Caribbean island nation of St. Lucia.

The North American area designation impacts the deductibility of convention expenses. A taxpayer may deduct expenses incurred in attending a foreign convention, seminar or similar meeting held outside of the North American area only if it is directly related to the active conduct of the taxpayer's trade or business and if it is as reasonable to be held outside the North American area as within the North American area.

Code Sec. 274(h)(3)(A) defines the term North American area as the United States, its possessions, the Trust Territory of the Pacific Islands, Canada, and Mexico. The United States consists of the 50 states and the District of Columbia. The IRS treats the following as the possessions of the United States for this purpose: American Samoa, Baker Island, the Commonwealth of Puerto Rico, the Commonwealth of the Northern Mariana Islands, Guam, Howland Island, Jarvis Island, Johnston Island, Kingman Reef, the Midway Islands, Palmyra Atoll, the U. S. Virgin Islands, Wake Island, and other U. S. islands, cays, and reefs not part of the 50 states or the District of Columbia.

The Trust Territory of the Pacific Islands is no longer in existence. In its place are the Republic of the Marshall Islands, the Federated States of Micronesia, and the Republic of Palau, which are covered by the compacts with the United States.

The North American area also includes any beneficiary country of the Caribbean Basin Economic Recovery Act and Bermuda. A bilateral or multilateral agreement relating to the exchange of information must be in effect between such country and the United States at the time the meeting begins for one of these countries to be considered part of the North American area. The IRS also must determine that the tax laws of the country do not discriminate against conventions held in the United States.

In 2011, the United States entered into a tax information exchange agreement with Panama that satisfies Code Sec. 274(h). Therefore, the IRS determined that Panama is a beneficiary country for purposes of the North American area.

Three other locations, the Cayman Islands, the British Virgin Islands, and Saint Lucia, have entered into tax information exchange agreements with the United States. However, certain limitations in the scope or implementation of those agreements preclude these countries from being part of the North American area, the IRS explained.

St. Lucia, however, qualifies for transition relief. The IRS will treat Saint Lucia as not included in the North American area under Code Sec. 274(h)(6) with respect to conventions that begin after April 4, 2007, except with respect to expenses for which the taxpayer demonstrates a non-refundable contractual obligation existing as of April 4, 2007.

Reference: PTE §9,540

Carrying on a Small Business in C Corporation Form: Not Always a Bad Idea

2011-11-21T14:31:00.000-06:00

Everybody knows that small businesses that are C corporations are subject to double taxation, but S corporations and limited liability companies (LLCs) taxed as partnerships or disregarded entities are only subject to tax at one level. Yet, according to a study released earlier this year by the U.S. Treasury Department, 1.56 million small businesses are C corporations.

Given the apparent tax disadvantage of the C corporation form, the question is why do so many small businesses choose to do business as C corporations. While poor or non-existent tax advice may be the reason some of these businesses are C corporations, there are legitimate reasons for a smaller business to choose to operate under subchapter C.

Tax Rates
Corporations are typically taxed at a lower rate than individuals. A C corporation determines its annual income tax liability by applying a progressive rate of tax to its taxable income, just like an individual, but the brackets are typically higher.

The corporate income tax rates consist of four brackets:

* The first $50,000 is subject to 15-percent tax.

* $50,001-$75,000 of income is subject to a 25-percent marginal rate.

* $75,000-$10 million in income is subject to a 34-percent rate.

* Any amounts over $10 million are subject to tax at a 35-percent rate.

The 34-percent rate is phased out by an additional five-percent rate on income between $100,000 and $335,000. The 35-percent rate is phased out by an additional three-percent rate on income over $15 million. The additional tax under the three-percent add-on is limited to $100,000.

Comment
The effect of the added rates is to impose a flat 35-percent rate on corporations whose taxable income exceeds $18.33 million and a flat 34-percent rate on corporations whose taxable income exceeds $335,000, but is $10 million or less.

Income tax is imposed on individuals for tax years beginning in 2011 at the following rates and bracket amounts:

* For married taxpayers filing jointly and surviving spouses, the maximum taxable income for the 10% tax bracket is $17,000; for the 15% bracket, $69,000; for the 25% bracket, $139,350; for the 28% bracket, $212,300; and for the 33% bracket, $379,150. Amounts over $379,150 are taxed at 35%.

* For single filers (other than surviving spouses and heads of households), the maximum taxable income for the 10% bracket is $8,500; for the 15% bracket, $34,500; for the 25% bracket, $83,600; for the 28% bracket, $174,400, and for the 33% bracket, $379,150. Amounts over $379,150 are taxed at 35%.

Compared head to head, the two tax structures are only somewhat different. Corporate tax rates for amounts lower than $379,150 generally compare unfavorably to those for joint filers, but may compare favorably or unfavorably for single individual taxpayers. For example, $50,000 of corporate taxable income would normally be subject to $7,500 of tax; however a single individual with $50,000 in taxable income will be subject to $8,625 in tax, $1,125 more. Amounts greater than $379,150 in corporate income will be taxed at a slightly lower rate (34 percent vs. 35 percent).

Caution
An apples-to-apples comparison may be difficult here because corporations do not receive tax benefits available to individuals, such as personal exemptions, that reduce individual taxable income.

However, the real advantage comes in when the corporation's shareholders have significant income from other sources. Since the top individual rates are 33 and 35 percent, any income from a business operated in a passthrough entity will be effectively taxed at those rates. In comparison, the rates on the income of corporations with less than $75,000 are either 15 or 25 percent.

However, that still leaves the owner with the problem of the second level of tax. First, though, note that the rates for qualified dividend income are already low, at 15 percent for upper-bracket taxpayers. Also, shareholders may avoid the second level of tax altogether by simply leaving the profits in the corporation (although, the accumulated earnings tax, see below, should be taken into consideration).

Comment
Leaving profits in the business is obviously a more viable strategy for taxpayers with other sources of income.

Payroll Taxes
As an alternative to taking earnings out of the business as dividends, C corporation owners may take them as compensation. Compensation is a deductible expense that will reduce corporate income, but is subject to FICA taxes. Before 2011 and in 2012, FICA taxes are imposed 7.65 percent on each of the corporation and the shareholder-employee. For 2011 only, the amount is reduced to 5.65 percent on the employees' portion, but remains at 7.65 percent on the employers' portion. For payments after December 31, 2012, an additional 0.9-percent surcharge is imposed on the wages of high-income individuals as part of the employee's share. Dividends are not subject to FICA tax.

In comparison, sole proprietors and individual owners of disregarded entities, as well as individual general partners and members of limited liability companies (LLCs) taxed as partnerships, are generally subject to self-employment (SECA) tax at rates equal to the FICA taxes imposed on wages. There is no way to avoid SECA taxes on sole proprietor, disregarded entity, or partnership income by paying dividends.

The payroll tax rules for S corporations are a hybrid of the C corporation and partnership/disregarded entity rules. Wages paid by an S corporation to its employees are subject to FICA taxes; however, S corporation income and distributions are not.

Caution
The temptation to avoid FICA altogether by making distributions but paying no wages to S corporation employee-shareholders should be avoided. The IRS may reclassify amounts of distributions as wages unless the S corporation pays its employee-shareholders reasonable compensation for their services.

Health Benefits
Another advantage offered by C corporations is the ability to offer tax-free health benefits to their employees. Health benefits provided to partners and 2-percent shareholders of S corporations are generally included in taxable income. The partner or shareholder receives an offsetting deduction, but the amount is still subject to FICA or SECA tax.

Accumulated Earnings Tax
A major problem with C corporations, and a factor that vitiates the tax advantages of keeping profits in the corporation, is the accumulated earnings tax. Accumulated earnings tax is imposed on corporations formed or availed of to avoid tax on shareholders by accumulating earnings.

For tax years beginning before 2013, the accumulated earnings tax is equal to 15 percent of accumulated taxable income. For tax years beginning after 2012, the tax is imposed at the highest rate of tax for single individuals. Accumulated taxable income is taxable income, with adjustments, reduced by dividends paid deduction and earnings accumulated for reasonable business needs or minimum credit amount.

Comment
Accumulated earnings tax only applies to C corporations and is not an issue for sole proprietorships, disregarded entities, partnerships and S corporations.

Losses
Another major disadvantage is the inability to take C corporation income against individual income. High-income individuals who might otherwise like the low rates available on C corporation income will not be able to use losses from the business to shelter their income from other sources.

Even businesses with positive cash flow will often incur tax losses in their first year or two because of accelerated depreciation and generous expensing allowances under Code Sec. 179. One strategy might be to start the business as a partnership or disregarded entity, whose losses would flow through to the individual return, and then convert it to a C corporation when it starts generating taxable income.

Additional Issues
In addition to the accumulated earnings tax, two other potential traps exist for small businesses that operate as C corporations: the additional taxes imposed on personal holding companies and personal service corporations.

A personal holding company is subject to additional tax on any undistributed personal holding company income. A corporation is personal holding company if more than 50 percent of its outstanding stock is owned, directly or indirectly, by five or fewer individuals, including organizations treated as individuals, and 60 percent or more of its adjusted ordinary income is personal holding company income. Personal holding company income includes dividends, rents, royalties and other specified types of passive or service income.

Comment
The personal holding company tax does not apply to sole proprietorships, partnerships, or S corporations.

A personal service corporation is defined as any corporation in which the principal activity is performance of personal service by the owner-employees. The IRS is authorized to disallow tax benefits, if the principal purpose for forming or availing of a personal service corporation is the avoidance or evasion of federal income tax.

Personal service corporations have several other disadvantages. The normal graduated rate structure of the corporate income tax does not apply to a qualified personal service corporation; instead, the 35-percent rate applies to all personal service corporation income. Moreover, personal service corporations are generally required to use a calendar tax year.

Conclusion
However, if these issues can be addressed or planned around, taxpayers may wish to rethink the supposed tax disadvantages of C corporations. High-income individual taxpayers with a side business generating income rather than losses should especially consider running the business as a C corporation, as the rates imposed on the business's income will be significantly lower.

FICA and FUTA Exemptions Extended to Family Members of Disregarded Entity Owners

2011-11-21T14:27:00.000-06:00

The IRS has issued final, temporary and proposed regulations extending the religious and family member Federal Insurance Contributions Act (FICA) and Federal Unemployment Tax Act (FUTA) exceptions to disregarded entities (T.D. 9554; NRPM REG-136565-09). The temporary regulations also clarify the existing rule that the owners of disregarded entities, except for qualified subchapter S subsidiaries, are responsible for backup withholding and related information reporting requirements.

Background
Payments for the services of a child under age 18 who works for his or her parent in a trade or business are not subject to Social Security and Medicare taxes if the trade or business is a sole proprietorship or a partnership in which each partner is a parent of the child. However, the wages for the services of a child are subject to Social Security, Medicare, and FUTA taxes if the child works for a corporation, even if controlled by the child's parent.

Generally, the wages for the services of an individual who works for his or her spouse in a trade or business are subject to Social Security and Medicare taxes, but not to FUTA tax. Similar rules apply to wages for services of a parent employed by his or her child.

Additionally, wages are not subject to Social Security tax when paid to an employee who is a member of a recognized religious group by an employer who is also a member of a recognized religious group. The employer and the employee must have filed and had approved an application certifying that they are members of a qualifying religious sect.

Prior to 2009, family members of the owner of a disregarded entity were considered employed by the owner of the disregarded entity and wages paid to them were exempt from FICA and FUTA under Code Secs. 3121(b)(3) , 3127, and 3306(c)(5). The FICA exemption also applied where an employee and the owner of a disregarded entity for which the employee worked were both members of a religious faith opposed to the Social Security Act.

In 2007, the IRS issued final regulations providing that, with respect to wages paid after December 31, 2008, a disregarded entity is treated as a separate entity for purposes of employment taxes and related reporting requirements. The separate entity is treated as a corporation for purposes of employment taxes. Under this treatment, the entity, rather than the owner, is the employer of any individual performing services for the entity.

Because of the 2007 regulations, family members of disregarded entities no longer qualify for the FICA and FUTA exceptions for family employment. Services performed in the employ of a corporation are not within the FICA and FUTA exceptions for family members and members of qualified religious sects.

The new regulations treat disregarded entities as corporations for employment tax purposes. Such entities cannot qualify for the FICA and FUTA exceptions contained in Code Secs. 3121(b)(3), 3127, and 3306(c)(5), because the individual owner is no longer considered the employer. The IRS did not intend to render these exceptions inapplicable to disregarded entities that were eligible for the exceptions prior to the effective date of the new regulations in Reg. §301.7701-2(c). The inability of these entities to benefit from the exceptions for family employees and members of religious faiths has an adverse impact on small businesses. Accordingly, a change is necessary to correct this problem.

Regulations
The temporary regulations allow certain disregarded entities to qualify for the FICA and FUTA exceptions. A disregarded entity will continue to be treated as a corporation for all employment tax purposes, except that the entity will be disregarded for the limited purposes of applying the FICA and FUTA exceptions found in Code Secs. 3121(b)(3), 3127, and 3306(c)(5). For purposes of applying these exceptions only, the owner of the disregarded entity will be treated as the employer and the employee will be considered to be an employee of the owner.

Additionally, the regulations clarify the existing rule that disregarded entities under Reg. §301.7701-2 are not responsible for backup withholding and information reporting of reportable payments under Code Sec. 3406. Rather, the owner of a disregarded entity is responsible for backup withholding and information reporting of reportable payments.

This does not change the existing rule. However, the existing final regulations do not explicitly state that disregarded entities are not responsible for information reporting and backup withholding, which has caused some confusion as to the responsible party for filing information returns for reportable payments and related backup withholding requirements. Therefore, the regulations have been amended to clarify the existing rules with respect to backup withholding and related information reporting responsibilities.

Comment
The text of the temporary regulations also serves as the text of the proposed regulations. The regulations, as proposed, apply to wages paid on or after October 31, 2011. However, the rules in the proposed regulations may be relied on by taxpayers for wages paid after December 31, 2008.

New 1099-K Issued

2011-11-21T12:44:00.000-06:00

The IRS has released the final 2011 Form 1099-K, Merchant Card and Third Party Network Payments, the form credit-card processors and similar firms will use to report the gross amount of transactions they process for both businesses and other organizations. Be aware of two key points:

1. How your firm's reported gross income will be checked out. The IRS has assigned a large number of codes for different types of businesses, and the 1099-K has a place for a merchant category code. Your credit-card processors categorize each business based on what they know about it. The IRS is expected to use the codes to learn more about different types of businesses and to identify those that might be under-reporting revenues based on what similar types of businesses report. Bottom line: Make sure your processors correctly categorize your firm.

2. Your reported gross may include nontaxable amounts. The 1099-K reports gross payments processed for your firm, but the total may include some nontaxable amounts, such as taxes, tips, cash-back and other nonrevenue or nontaxable items. The IRS says business income form instructions will tell you how to subtract those items from the gross to arrive at the amount to include in taxable income. The current plan is to have on business income tax forms a revenue line for the 1099-K amount and to have other lines for subtracting non-income intems.

GOP makes new offer on taxes, Medicare cuts

2011-11-09T11:16:00.000-06:00

'Supercommittee' Republicans make new offer on taxes, Medicare cuts as deadline approaches

By Andrew Taylor, Associated Press

WASHINGTON (AP) -- With a Thanksgiving deadline fast approaching, the GOP members of a deficit-reduction supercommittee are pressing a plan to cut the deficit by about $1.5 trillion over the coming decade, showing flexibility on tax revenue increases for the first time while pressing curbs on Medicare spending and a less generous cost-of-living increase for Social Security beneficiaries.

The plan floated by Republicans, including tea party favorite Sen. Pat Toomey of Pennsylvania, would place sharp limits on the total amount of tax deductions and credits that a person could claim, in exchange for significantly lower income tax rates. At the same time, Republicans are willing to accept a net increase in individual income tax revenues of about $300 billion over the coming decade.

The proposal, described by aides in both parties, also would cut spending by about $700 billion, mixing a less generous cost-of-living adjustment for Social Security beneficiaries with further cuts to agency operating budgets and curbs to the booming growth of Medicare and the Medicaid health care program for the poor and disabled. Other revenues would come from proposals such as auctioning broadcast spectrum, raising Medicare premiums and increasing aviation security fees.

Republicans also support raising the Medicare eligibility age to 67 for future retirees, but GOP and Democratic aides offered different accounts of whether the idea was officially part of the proposal. Democrats said it was in the plan; Republicans say it was part of the discussion but not an official GOP position.

The supercommittee has been super-secret in its deliberations and each of the aides spoke on condition of anonymity because they were not authorized to speak publicly about the negotiations.

The GOP offer, discussed by a bipartisan subgroup of supercommittee lawmakers Monday evening, contrasts with a Democratic plan introduced last month that proposed revenue increases of about $1.3 trillion that would also be netted after a rewrite of the loophole-cluttered federal tax code. Both proposals are similar in concept to ideas discussed last summer in negotiations between House Speaker John Boehner, R-Ohio, and President Barack Obama.

Democrats dismissed the GOP plan as inadequate.

"I have yet to see a real, credible plan that raises revenue in a significant way to bring us to a fair, balanced proposal," said Sen. Patty Murray, D-Wash., the co-chair of the 12-member supercommittee.

During talks on legislation needed to increase the government's borrowing cap, Boehner and Obama discussed a complete overhaul of the tax code that would have garnered some $800 billion in new revenue over a decade.

But the Boehner-Obama talks fell apart over taxes and benefit cuts, and the final legislation included cuts to the day-to-day operating budgets of Cabinet agencies totaling $900 billion over a decade -- and establishment of the deficit panel with unusual powers to develop a plan for further cuts. The panel is charged with coming up with $1.2 trillion in deficit cuts over a decade; failure to accomplish the goal would trigger automatic spending cuts across a wide range of federal programs.

The plan proposed Monday was more modest, congressional aides said, raising about $250 billion from individual tax reform and another $40 billion from using a new inflation adjustment when updating the income levels for tax brackets. An overhaul of the corporate tax code could raise another $60 billion, the aides said.

Aides to supercommittee Democrats attacked the proposal, saying the GOP plan for a top individual tax rate of 28 percent would give wealthier earners large tax cuts while sharply cutting back tax breaks important to middle class workers such as deductions for mortgage interest and state and local taxes. And they said the proposed tax increases were too small when measured against the nation's huge debt.

The GOP plan assumes that the full menu of Bush-era tax cuts -- including a generous cut in the estate tax enacted last year -- would be made permanent when calculating the revenue "baseline" from which to start tax reform.

Democrats said the $300 billion or so GOP revenue proposal was a pittance relative to the size of the deficit problem. The government ran a $1.3 trillion deficit in the recently-completed budget year.

Obama wants to eliminate the Bush tax cuts for upper-income earners, which would generate about $800 billion in revenue over the coming decade.

The top tax bracket is presently 35 percent and is set to rise to 39.6 percent when the Bush-era tax cuts expire at the end of next year.

Democratic aides said the offer was mostly spin and that the GOP tax proposals would wipe out tax deductions important to middle- and lower-income households to pay for rate cuts for the wealthy, but some Democratic members of the panel weren't as quick to dismiss it.

Asked whether Republicans were negotiating seriously, supercommittee member Sen. Max Baucus, D-Mont., said, "Oh, yes, I think so. On balance, yes."

Toomey was the chief sponsor of the offer but has support from other Republicans on the panel. The supercommittee is charged with producing legislation to cut $1.2 trillion from the deficit over the coming decade. The fact that Toomey, who was elected last year with tea party support, was willing to entertain higher tax revenues was a noteworthy break from an earlier GOP proposal forwarded two weeks ago that assumed revenue would come chiefly from non-tax sources like Medicare premiums and economic growth spurred by a simplified tax code.

"We've made a little bit of progress but it's not enough, in our judgment," said Sen. John Kerry, D-Mass., a member of the deficit panel. "We have some distance to go."

IRS Issues Further Guidance on Exams Involving Uncertain Tax Positions

2011-11-03T11:00:00.000-05:00

By Rachel Boehm

The Internal Revenue Service Large Business & International Division issued Nov. 1 a memorandum to provide further Schedule UTP, Statement of Uncertain Tax Position, guidance and procedures applicable to LB&I examinations not covered by May and August memorandums.

The memorandum from Commissioner Heather Maloy requires LB&I examiners and specialists, and their respective team and territory managers, to complete a just-in-time UTP training session and the prerequisite tax reserve training prior to reviewing a return that includes a Schedule UTP, Maloy said, or prior to examining an issue disclosed on a Schedule UTP. The training module will be available by Dec. 31.

Under the uncertain tax positions reporting requirement, taxpayers are required to provide a brief description of each uncertain position and to rank them, in general using the size of the reserve recorded for the position but not disclosing the actual reserve amount.

Maloy's previous memos covered initial LB&I procedures and the use of Schedule UTP as part of the compliance assurance process (CAP) program that applied only to returns filed for the 2010 tax year by taxpayers that were in CAP in 2010.

Centralized Review, Audit Process

Any return containing a Schedule UTP will undergo a compliance assessment by a Centralized Review Team prior to release to the field, according to the memo. Taxpayers will be contacted if issues arise related to the information contained in the schedule. When returns are assigned, examiners and specialists should not further evaluate the compliance of the schedule, IRS said, but should send an e-mail to *UTP@irs.gov with questions or concerns.

The mere presence of a return with a Schedule UTP should not prompt an examination, IRS said. Rather, the Schedule UTP is to be used in conjunction with the Quality Examination Process (QEP), IRS said. Any decision to select a return for audit should be based on findings from the risk analysis, discussions with the taxpayer, materiality considerations, and other steps outlined in the planning phase of the QEP, IRS said.

The same rules and procedures regarding the issuance of Integrated Data Retrieval System (IDRS) contained in the QEP Reference Guide apply to returns with Schedule UTP, according to the memo.

The complete text of this article can be found in the BNA Daily Tax Report, November 2, 2011 (http://www.bnasoftware.com/News/Tax_News/Articles/IRS_Issues_Further_Guidance_on_Exams_Involving_Uncertain_Tax_Positions.asp).

© 2011, The Bureau of National Affairs, Inc.

States ponder sports betting as source of new revenue

2011-11-03T10:38:00.000-05:00

By Pamela M. Prah, Stateline Staff Writer

A 34-year-old New Jersey man beat odds of more than 32,000-to-1 last month when he correctly picked the winners of 15 National Football League games against the point spread on a $5 wager. He collected $100,000.

He couldn’t place such a bet legally in New Jersey, but he could by using the Delaware lottery. Delaware is currently the only state outside Nevada that sanctions betting on the outcome of NFL games. It has a football gambling venture called the “$100,000 Parlay Card,” which it introduced in 2009. Nobody had hit the jackpot on it until now.

With revenues still far below pre-recession levels and demand for services still high, states around the country are looking to tap into the billions of dollars in play with the popularity of Super Bowl wagers and March Madness pools. One of the new entrants may be New Jersey. Voters there will go to the polls November 8 and consider a ballot measure that would legalize sports betting.

Gambling revenue plays a “consistently significant, if relatively small, role in state budgets,” Lucy Dadayan of the Nelson A. Rockefeller Institute of Government wrote in the latest report on gambling revenues. Dadayan found that, on average, gambling money represented 2.4 percent of revenue for states in 2009. But the percentage is much higher for some states. Nevada’s 12.5 percent is the highest in the country; Delaware takes in double the national average at 4.9 percent. New Jersey, without sports betting but with a clutch of Atlantic City casinos, gets 3.5 percent.

Even if New Jersey voters approve the ballot measure next week in hopes of bringing in more revenue, it may be a while before gamblers will be able to bet on NFL games in casinos or the state’s racetracks, as they can in Nevada. That’s because a 1992 federal law, the Professional and Amateur Sports Protection Act, prohibits sports betting except in four states that were grandfathered in because they already had sports wagering programs: Nevada, Delaware, Montana and Oregon.

“While it amends the New Jersey Constitution, this ballot measure will not have any practical effect unless the federal government lifts its ban on sports betting,” said David Redlawsk, the director of a recent Rutgers-Eagleton Poll that showed 58 percent of likely voters supported the measure.

Growth amid recession

As in previous economic downturns, states have been looking to expand gambling in a variety of ways to patch holes in their budgets. Some 10 states went that route in fiscal 2010, including Pennsylvania, which added poker and table games at casinos. This year, lawmakers in Florida, Illinois and Massachusetts have debated whether to build new destination casinos in major cities, such as Chicago and Miami. And Maine will have a repeat vote next week on whether to add slot machines at certain race tracks.

But betting on the big-time sports events is different.

State Senator Raymond Lesniak is pushing the ballot measure in New Jersey because a lawsuit he filed to overturn the federal sports betting restriction was tossed out. He calls sports betting “a tool to help raise needed revenues for our state and our struggling gaming and wagering industry.” Lesniak has vowed to introduce legislation setting up a sports wagering program as soon as voters give their blessing.

Greg Gemignani, who specializes in gaming law at the Nevada law firm of Lionel Sawyer & Collins, says New Jersey is “fighting an uphill battle” to undo the federal ban, especially in light of opposition from the National Football League. In 2009, the league led a successful fight against a bill in Delaware that would have allowed that state to join Nevada in permitting unrestricted betting on individual sports contests.

Instead, Delaware launched the NFL “parlay” games, which involves betting on multiple games. It was free to do that, says Vernon Kirk, acting director of the Delaware Lottery, because the state had experimented with NFL parlay games during the 1970s, before the federal restrictions took effect. The state has several parlay offerings, with the most recent allowing the $100,000 winnings on a $5 wager. The cards are available only at Delaware’s three racetrack casinos.

A piece of the gambling pie

Compared to other kinds of gambling, sports betting doesn’t bring in a ton of tax revenue even where it is legal. But it can be a significant source. Nevada casinos paid $652 million dollars in “percentage fee” taxes to the state’s general fund based on their taxable gaming revenue in fiscal 2011, and sports betting accounted for approximately $10.4 million of this amount — 1.59 percent of the state’s total percentage fee collections, says Michael Lawton of the Nevada Gaming Control Board.

The amount is much smaller in Delaware since the betting is new and limited to parlay games. Sports betting brought in $1.6 million to Delaware’s state budget in its first year, $2.1 million in its second year, and so far this year has generated about $1.25 million, Kirk says. That is a tiny portion of the total take from Delaware’s lottery, which set a record in fiscal 2011, providing $287 million to the general state fund.

Montana does not permit wagers on individual games, but because it too had sports betting prior to 1992, it has been offering “fantasy football” and “fantasy racing” for the past several years. Bettors can create their own fantasy teams based on certain players or drivers. The prize pool depends on how many people play. But the amount of money involved is small. Recent first prize winners in fantasy football have won some $1,600, while the payout for recent winners in fantasy racing totaled about $500. These games brought in less than $10,000 to the state lottery in 2010.

Oregon, the one other state that can legally conduct sports betting, did so until 2007. It ended the practice, in part, because the National Collegiate Athletic Association would not consider locating basketball tournament games there while gambling on any form of sports was permitted.

Spillover effect

The relatively small numbers may make sports wagering may seem immaterial to total gaming revenues, but Lawton in Nevada says the true importance is difficult to quantify. He says sports betting spills over into other revenue generating areas, such as slots, hotel rooms, food and beverages, shows and shopping.

Lawton argues that sports betting is important to his state because it offers gamblers a product no other state can legally offer in as complete a form. “The Super Bowl and March Madness are two of the biggest events in the state,” he says, “and their economic impact is immense. I couldn’t imagine what February and March would be like without them.”

That’s precisely why New Jersey’s Senator Lesniak wants voters to approve the sports betting ballot measure next week and is trying to upend the federal ban. He also is pushing to legalize online gambling, which supporters say could bring much more revenue to the states than sports betting.

But online gambling raises just as many legal and moral issues as sports betting, plus some technical ones. Earlier this year, New Jersey Governor Chris Christie vetoed a bill from Senator Lesniak that would have allowed New Jersey residents to place bets online through websites based in Atlantic City. Christie, a Republican, said voters should have a chance to express themselves on the subject, as well as citing other concerns.

Online gambling is essentially illegal under a 2006 federal law, but supporters hope the size of the federal deficit will prompt Congress to reconsider and make it legal. The American Gaming Association, which has opposed efforts to legalize internet gambling in the past, says it could support its legality now, but only for poker, because that game is based on skill and because new technology would prevent minors from accessing the sites. The AGA figures that allowing online poker could bring in $2 billion a year in tax revenue, mostly for states.

But not all state officials are on board. Maryland Governor Martin O’Malley last month urged the congressional “super committee” charged with deficit reduction to reject online gaming proposals. In Maryland, the Democratic governor wrote, “federalized poker and casino gambling would put at risk the $519 million annually we generate from our state lottery,” jeopardizing the jobs and business of lottery retailers.

IRS Announces Pension Plan Limitations for 2012

2011-11-02T12:53:00.000-05:00

IR-2011-103, Oct. 20, 2011

WASHINGTON — The Internal Revenue Service today announced cost of living adjustments affecting dollar limitations for pension plans and other retirement-related items for Tax Year 2012. In general, many of the pension plan limitations will change for 2012 because the increase in the cost-of-living index met the statutory thresholds that trigger their adjustment. However, other limitations will remain unchanged. Highlights include:

* The elective deferral (contribution) limit for employees who participate in 401(k), 403(b), most 457 plans, and the federal government’s Thrift Savings Plan is increased from $16,500 to $17,000.

* The catch-up contribution limit for those aged 50 and over remains unchanged at $5,500.

* The deduction for taxpayers making contributions to a traditional IRA is phased out for singles and heads of household who are covered by a workplace retirement plan and have modified adjusted gross incomes (AGI) between $58,000 and $68,000, up from $56,000 and $66,000 in 2011. For married couples filing jointly, in which the spouse who makes the IRA contribution is covered by a workplace retirement plan, the income phase-out range is $92,000 to $112,000, up from $90,000 to $110,000.

For an IRA contributor who is not covered by a workplace retirement plan and is married to someone who is covered, the deduction is phased out if the couple’s income is between $173,000 and $183,000, up from $169,000 and $179,000.

* The AGI phase-out range for taxpayers making contributions to a Roth IRA is $173,000 to $183,000 for married couples filing jointly, up from $169,000 to $179,000 in 2011. For singles and heads of household, the income phase-out range is $110,000 to $125,000, up from $107,000 to $122,000. For a married individual filing a separate return who is covered by a retirement plan at work, the phase-out range remains $0 to $10,000.

* The AGI limit for the saver’s credit (also known as the retirement savings contributions credit) for low-and moderate-income workers is $57,500 for married couples filing jointly, up from $56,500 in 2011; $43,125 for heads of household, up from $42,375; and $28,750 for married individuals filing separately and for singles, up from $28,250.

Below are details on both the unchanged and adjusted limitations.

Section 415 of the Internal Revenue Code provides for dollar limitations on benefits and contributions under qualified retirement plans. Section 415(d) requires that the Commissioner annually adjust these limits for cost of living increases. Other limitations applicable to deferred compensation plans are also affected by these adjustments under Section 415. Under Section 415(d), the adjustments are to be made pursuant to adjustment procedures which are similar to those used to adjust benefit amounts under Section 215(i)(2)(A) of the Social Security Act.

The limitations that are adjusted by reference to Section 415(d) generally will change for 2012 because the increase in the cost-of-living index met the statutory thresholds that trigger their adjustment. For example, the limitation under Section 402(g)(1) on the exclusion for elective deferrals described in Section 402(g)(3) will increase from $16,500 to $17,000 for 2012. This limitation affects elective deferrals to Section 401(k) plans, Section 403(b) plans, and the Federal Government’s Thrift Savings Plan.

Effective January 1, 2012, the limitation on the annual benefit under a defined benefit plan under section 415(b)(1)(A) is increased from $195,000 to $200,000.

Under section 1.415(d)-1(a)(2)(ii) of the Income Tax Regulations, the adjustment to the limitation under a defined benefit plan under section 415(b)(1)(B) is determined using a special rule. This special rule takes into account the following recent history of changes in the cost-of-living indexes: (1) the cost-of-living index for the quarter ended September 30, 2009, was less than the cost-of-living index for the quarter ended September 30, 2008; (2) the cost-of-living index for the quarter ended September 30, 2010, was greater than the cost-of-living index for the quarter ended September 30, 2009, but less than the cost-of-living index for the quarter ended September 30, 2008; and (3) the cost-of-living index for the quarter ended September 30, 2011, was greater than the cost-of-living indexes for all prior periods.

For a participant who separated from service before January 1, 2010, the limitation under a defined benefit plan under Section 415(b)(1)(B) for 2012 is computed by multiplying the participant's 2011 compensation limitation by 1.0327 in order to reflect changes in the cost-of-living index from the quarter ended September 30, 2008, to the quarter ended September 30, 2011. For a participant who separated from service during 2010 or 2011, the limitation under a defined benefit plan under Section 415(b)(1)(B) for 2012 is computed by multiplying the participant's 2011 compensation limitation by 1.0376 in order to reflect changes in the cost-of-living index from the quarter ended September 30, 2010, to the quarter ended September 30, 2011.

The limitation for defined contribution plans under Section 415(c)(1)(A) is increased in 2012 from $49,000 to $50,000.

The Code provides that various other dollar amounts are to be adjusted at the same time and in the same manner as the dollar limitation of Section 415(b)(1)(A). After taking into account the applicable rounding rules, the amounts for 2012 are as follows:

The limitation under Section 402(g)(1) on the exclusion for elective deferrals described in Section 402(g)(3) is increased from $16,500 to $17,000.

The annual compensation limit under Sections 401(a)(17), 404(l), 408(k)(3)(C), and 408(k)(6)(D)(ii) is increased from $245,000 to $250,000.

The dollar limitation under Section 416(i)(1)(A)(i) concerning the definition of key employee in a top-heavy plan is increased from $160,000 to $165,000.

The dollar amount under Section 409(o)(1)(C)(ii) for determining the maximum account balance in an employee stock ownership plan subject to a 5 year distribution period is increased from $985,000 to $1,015,000, while the dollar amount used to determine the lengthening of the 5 year distribution period is increased from $195,000 to $200,000.

The limitation used in the definition of highly compensated employee under Section 414(q)(1)(B) is increased from $110,000 to $115,000.

The dollar limitation under Section 414(v)(2)(B)(i) for catch-up contributions to an applicable employer plan other than a plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $5,500. The dollar limitation under Section 414(v)(2)(B)(ii) for catch-up contributions to an applicable employer plan described in Section 401(k)(11) or Section 408(p) for individuals aged 50 or over remains unchanged at $2,500.

The annual compensation limitation under Section 401(a)(17) for eligible participants in certain governmental plans that, under the plan as in effect on July 1, 1993, allowed cost of living adjustments to the compensation limitation under the plan under Section 401(a)(17) to be taken into account, is increased from $360,000 to $375,000.

The compensation amount under Section 408(k)(2)(C) regarding simplified employee pensions (SEPs) remains unchanged at $550.

The limitation under Section 408(p)(2)(E) regarding SIMPLE retirement accounts remains unchanged at $11,500.

The limitation on deferrals under Section 457(e)(15) concerning deferred compensation plans of state and local governments and tax-exempt organizations is increased from $16,500 to $17,000.

The compensation amounts under Section 1.61 21(f)(5)(i) of the Income Tax Regulations concerning the definition of “control employee” for fringe benefit valuation purposes is increased from $95,000 to $100,000. The compensation amount under Section 1.61 21(f)(5)(iii) is increased from $195,000 to $205,000.

The Code also provides that several pension-related amounts are to be adjusted using the cost-of-living adjustment under Section 1(f)(3). After taking the applicable rounding rules into account, the amounts for 2012 are as follows:

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for married taxpayers filing a joint return is increased from $34,000 to $34,500; the limitation under Section 25B(b)(1)(B) is increased from $36,500 to $37,500; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $56,500 to $57,500.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for taxpayers filing as head of household is increased from $25,500 to $25,875; the limitation under Section 25B(b)(1)(B) is increased from $27,375 to $28,125; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $42,375 to $43,125.

The adjusted gross income limitation under Section 25B(b)(1)(A) for determining the retirement savings contribution credit for all other taxpayers is increased from $17,000 to $17,250; the limitation under Section 25B(b)(1)(B) is increased from $18,250 to $18,750; and the limitation under Sections 25B(b)(1)(C) and 25B(b)(1)(D), is increased from $28,250 to $28,750.

The deductible amount under § 219(b)(5)(A) for an individual making qualified retirement contributions remains unchanged at $5,000.

The applicable dollar amount under Section 219(g)(3)(B)(i) for determining the deductible amount of an IRA contribution for taxpayers who are active participants filing a joint return or as a qualifying widow(er) is increased from $90,000 to $92,000. The applicable dollar amount under Section 219(g)(3)(B)(ii) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $56,000 to $58,000. The applicable dollar amount under Section 219(g)(7)(A) for a taxpayer who is not an active participant but whose spouse is an active participant is increased from $169,000 to $173,000.

The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(I) for determining the maximum Roth IRA contribution for married taxpayers filing a joint return or for taxpayers filing as a qualifying widow(er) is increased from $169,000 to $173,000. The adjusted gross income limitation under Section 408A(c)(3)(C)(ii)(II) for all other taxpayers (other than married taxpayers filing separate returns) is increased from $107,000 to $110,000.

The dollar amount under Section 430(c)(7)(D)(i)(II) used to determine excess employee compensation with respect to a single-employer defined benefit pension plan for which the special election under section 430(c)(2)(D) has been made is increased from $1,014,000 to $1,039,000.

IRS Proposes Regulations Eliminating De Minimis Partner Rule (NRPM REG-109564-10)

2011-10-26T07:12:00.000-05:00

Proposed regulations issued by the IRS would eliminate the de minimis partner rule by removing Reg. §1.704-1(b)(2)(iii)(e) because the rule may have resulted in unintended tax consequences. Under the allocation rule of Code Sec. 704(a), a partner’s distributive share of income, gain, loss, deduction or credit is determined according to the partnership agreement. Code Sec. 704(b) limits the flexibility of this rule by requiring, in cases where the allocation does not have a substantial economic effect, that the allocation be in accordance with the partners’ interests in the partnership. Whether an allocation has a substantial economic effect is determined through a two-part analysis under Reg. §1.704-1(b)(2).

The de minimis partner rule provides that, for purposes of applying the substantiality rules, the tax attributes of de minimis partners (those who own less than 10 percent of the capital and profits of a partnership, and who are allocated less than 10 percent of each partnership item) need not be taken into account. However, the rule was not designed to produce certain outcomes, such as application to a partnership in which no partner meets these 10-percent qualifications. Therefore, the IRS has proposed eliminating the de minimis partner rule to avoid these unwanted effects.

Proposed Regulations, NPRM REG-109564-10, 2011FED ¶49,500

Other References:

Code Sec. 704

CCH Reference – 2011FED ¶25,122N

Tax Research Consultant

CCH Reference – TRC PART: 21,200

CCH Reference - TRC PART: 21,304

3 Tax-Savings Deals at Your Job

2011-10-19T11:00:00.000-05:00

Open enrollment time is right around the corner. Here's how to take advantage.

By BILL BISCHOFF

Times are tough, and conserving cash is important. One easy way to do that is by taking advantage of tax-saving opportunities at your job. Soon it will be time to sign up for these deals for 2012 during your employer's open-enrollment period. Here's what you need to know to about three options that can painlessly increase your monthly cash flow by reducing your taxes.

Healthcare Flexible Spending Account

Under an employer-sponsored health care flexible spending account (FSA) plan, you make an election this year to contribute a designated amount of next year's salary to your personal FSA. Contributions will be withheld from your 2012 paychecks. You can then use the FSA money to reimburse yourself for uninsured medical expenses (insurance deductibles and co-payments, prescriptions, dental and vision care and so forth).

The total amount withheld from your paychecks is treated as a "salary reduction" for federal income tax, Social Security tax and Medicare tax purposes (usually for state income tax purposes, too). Reimbursements from the FSA are tax-free. (Many employers place an annual cap, often $3,000, on the amount an employee can contribute to a health care FSA.)

The health care FSA deal allows you to pay for all or a portion of your 2012 medical costs with pretax dollars. That's the same as getting an income tax deduction combined with a reduction in your Social Security and Medicare tax withholding. The tax savings are permanent, not just a timing difference. However, you must enroll in your company's FSA plan to benefit, and the deadline for 2012 will likely be in the next month or two (check with your employer).

The only downside of the FSA deal is the dreaded "use it or lose it" rule. If you fail to incur enough qualified health care expenses to drain your health care FSA each year, any leftover balance reverts to your employer. In other words, you cannot carry over unused 2012 FSA contributions to cover 2013 expenses. However, your company's plan may allow a 2 -month grace period to ease this concern. If so, you will have until March 3, 2013, to incur expenses to be reimbursed out of your 2012 contributions. In any case, you should carefully estimate your expected health care expenditures before deciding how much to contribute for 2012.

Dependent Care Flexible Spending Account

Many FSA plans are also set up to reimburse employees for qualified dependent care expenses, which means costs to care for an under-age-13 dependent child, a disabled spouse, or a disabled person for whom you provide over half the support. The dependent care expenses must be necessary in order for you to work, or for both you and your spouse to work if you are married. The annual amount contributed for dependent care expenses cannot exceed $5,000, or $2,500 if you are married and file separately from your spouse. If you are married and file jointly, the $5,000 limit represents a combined maximum for both you and your spouse.

The total amount of dependent care FSA contributions withheld from your paychecks for the year is treated as a salary reduction for federal income tax, Social Security tax, and Medicare tax purposes (and usually for state income tax purposes as well). Reimbursements from the FSA are tax-free. So, once again, this deal allows you to pay expenses with pretax dollars, which puts extra cash in your pocket. Once again, the tax savings are permanent, but you must sign up during the upcoming open enrollment period to benefit.

Note that the "use it or lose it" rule also applies to dependent care FSAs, so make sure you don't contribute more than the qualified expenses you expect to incur.

Transportation Expenses

Your employer may also allow you to sign up to reduce your 2012 salary to pay for transit passes, van pooling, and parking to get to and from work. The maximum monthly amount you can set aside in 2012 for transit passes and van pooling (separately or together) will probably be $240 (or $125 if our beloved Congress fails to extend the current higher limit). The maximum monthly amount for parking in 2012 will be $240. If you sign up for both deals (say for the train to go to and from work and for parking at a park-and-ride lot near your home), you can combine the two limits.

Once again, the total amount withheld from your 2012 paychecks will be treated as a salary reduction for federal income tax, Social Security tax and Medicare tax purposes (and usually for state income tax purposes as well). So, once again, this deal allows you to pay expenses with pretax dollars, which puts extra cash in your pocket every month.

The Bottom Line

Surveys repeatedly show that most folks fail to participate in these employer-sponsored tax-saving arrangements, apparently because they figure the tax savings don't really add up to that much. Not true. For example, say your combined federal and state income tax rate for 2012 will be 33%, and you sign up to reduce next year's salary by a total of $10,880 ($3,000 for health care FSA contributions, $5,000 for dependent care FSA contributions, and $2,880 for monthly parking). Your income tax savings would be $3,590 ($10,880 x 33%), and your Social Security and Medicare tax savings could be as much as $832 ($10,880 x 7.65%). So we are talking about putting an extra $4,422 in your pocket, which amounts to $368 a month, just for filling out the enrollment forms. Be smart: Sign up to participate. It's worth the small effort.

Free Lunch: Deducting Expenses You Never Paid

2011-10-19T10:58:00.000-05:00

In certain situations, you can claim tax deductions for expenses that someone else paid.

By BILL BISCHOFF

In a 2010 decision, the U.S. Tax Court concluded that a daughter could deduct medical expenses and real estate taxes on her Form 1040 -- even though they were paid by her mother. This outcome may surprise you, because you probably think a taxpayer can never deduct expenses that were paid by someone else. As this Tax Court decision proved, that is not necessarily true. Here are some cases where you can claim tax deductions for expenses you didn't pay.

Medical Expenses

You can deduct medical expenses to the extent they exceed 7.5% of your adjusted gross income. In the 2010 Tax Court decision, the Internal Revenue Service argued that the daughter could not deduct the expenses because she did not pay for them with her own money. The Tax Court disagreed. The facts of the case demonstrated that the mother intended the payments, which were paid directly to the medical-service providers and local government, to be gifts. Therefore, the Tax Court characterized the transactions as gifts from the mother to the daughter, followed by payment of the expenses by the daughter using those gifted funds. The daughter was allowed to count nearly $25,000 of medical expenses that were actually paid by the mother, plus some expenses the daughter paid with her own funds, in calculating her medical-expense deduction.

Thanks to the tax-law exemption for gifts that are made in the form of direct payments to medical-service providers, the mother's payment of the medical expenses had no federal gift tax consequences for her.

Important Point: When you directly pay medical expenses for a person who is your dependent (meaning you pay over 50% of that person's total support), you can add the expenses you pay for the dependent to your own expenses and claim a deduction for the total to the extent it exceeds 7.5% of your adjusted gross income. In the Tax Court case, the daughter was evidently not the mother's dependent, so the deduction for the daughter's expenses belonged to the daughter rather than the mother.

Real Estate Taxes

The daughter in the 2010 Tax Court decision was also allowed to claim an itemized deduction for more than $5,500 of local real estate taxes that were actually paid by the mother, plus some taxes that the daughter paid with her own funds. Thanks to the annual federal gift tax exclusion (currently $13,000), the mother's payment of the real estate taxes had no federal gift tax consequences because it was less than the $12,000 gift tax exclusion that applied for the year in question (2006).

Seller-Paid Points for Home Mortgage

Assuming you itemize deductions, you can write off points (including loan origination fees) that you pay to take out a mortgage to buy your principal residence. Surprisingly enough, you can also deduct mortgage points paid by the seller on your behalf to sweeten the deal. In fact, IRS Revenue Procedure 94-27 actually requires you to claim the deduction. Don't ask questions. Just follow directions and claim that deduction, even though the seller paid for it.

The Moral of the Story

When it comes to deductions for certain expenditures, the question of who actually paid for them may not decide who is entitled to deduct them. Do not automatically assume you can't deduct expenses that were actually paid by someone else. Sometimes there is such a thing as a free lunch. Contact your friendly tax pro when you have questions about who is allowed to claim write-offs in various circumstances. You may be surprised by what you hear.

First Class stamp will rise to 45 cents in 2012

2011-10-19T10:52:00.000-05:00

Phoenix Business Journal by Jeff Clabaugh, Broadcast/Web Reporter

The U.S. Postal Service has announced rate increases for 2012 that will raise the cost of a Forever Stamp one penny to 45 cents, the first increase in First Class postage in more than two years.

The Postal Service will also raise the cost of a post card 3 cents to 32 cents, raise the cost of letters to Canada or Mexico by 5 cents to 85 cents and raise the cost of letters to other international destinations by 7 cents to $1.05.

“The overall price increase is small and is needed to help address our current financial crisis,” said Postmaster General Patrick Donahoe. “We continue to take actions within our control to increase revenue in other ways and to aggressively cut costs.”

The new prices go into effect Jan. 22, 2012.

Success-based Fees

2011-10-17T11:30:00.000-05:00

California CPA: October 2011

IRS Revenue Procedure & Directive Offer Favorable Taxpayer Developments

By Jeffrey M. Hurok

Revenue Procedure 2011-29, released by the IRS April 8, addresses the federal income tax treatment of success-based fees incurred in connection with certain acquisitive transactions for fees incurred within taxable years ending on or after April 8, 2011.

Rev. Proc. 2011-29 provides a safe harbor that may simplify the analysis of—and potentially results in—favorable treatment for fees within its scope. However, one must keep in mind that it does not address the treatment of all acquisition cost issues. Also, a taxpayer may be entitled to more favorable treatment than the revenue procedure provides.

Accordingly, Rev. Proc. 2011-29 complements, rather than replaces, an analysis of acquisition-related costs.

Soon after it issued Rev. Proc. 2011-29, the IRS directed the Large Business & International (LB&I) examiners July 28 not to challenge a taxpayer’s treatment of success-based fees paid or incurred in connection with transactions described within Rev. Proc. 2011-29 for fees incurred in taxable years ended before April 8, 2011—provided that the taxpayer’s original return position to capitalize such fees consistent with the safe harbor amount described in Rev. Proc. 2011-29.

Tax Treatment of Transaction Related Costs

Treasury Regulation Sec. 1.263(a)-5 (the Transaction Cost Regulations), generally requires a taxpayer to capitalize costs incurred to investigate or otherwise pursue a variety of corporate transactions, including certain stock acquisitions, asset acquisitions, reorganizations, IPOs and borrowings.

One exception: A taxpayer is not required to capitalize all costs incurred to investigate or pursue certain acquisitive transactions, generally including taxable asset acquisitions of a trade or business, certain taxable stock acquisitions and certain tax-free reorganizations (defined to be covered transactions).

This exception requires a taxpayer to capitalize costs incurred to investigate or otherwise pursue a covered transaction only if the fees relate to activities performed on or after the “bright line date,” or if such fees are for certain “inherently facilitative” activities, regardless of when they occur.

Put another way, the Transaction Cost Regulations don’t require capitalization for fees and costs incurred before the bright line date and are for non-inherently facilitative activities.

The Transaction Cost Regulations generally define the bright line date as the earlier of the date that the parties enter into a letter of intent, exclusivity or similar arrangement, or the date that a taxpayer’s board of directors authorizes the material terms of the deal.

The Transaction Cost Regulations define inherently facilitative activities to be:

* Securing a fairness opinion

* Structuring the transaction

* Preparing and reviewing the documents that effectuate the transaction (e.g., purchase agreement)

* Obtaining shareholder approval

* Obtaining regulatory approval

* Conveying property

Because the Transaction Cost Regulations do not require a taxpayer undertaking a covered transaction to capitalize amounts incurred for non-inherently facilitative activities performed before the bright line date, a taxpayer must analyze whether such costs are deductible or amortizable under IRC secs. 162 or 195.

To take advantage of this exception to the general rule of capitalization, a taxpayer undertaking a covered transaction must be able to allocate a portion of its fees to non-inherently facilitative activities performed before the bright line date. While some service providers (e.g., law firms) may make this allocation easier by keeping detailed time records, allocations for service providers that charge on a success-based fee basis, such as investment bankers, are more difficult because they tend not to keep time-based records.

To allocate success-based fees prior to Rev. Proc. 2011-29, a taxpayer generally would obtain an allocation letter from the service provider and assemble other documentation corroborating the provider’s activities performed for the taxpayer. Typical documentation includes reports produced by the service provider (e.g., a confidential information memorandum), board presentations (e.g., made by the service provider or referencing the service provider’s work), meeting records, emails and other documents that describe the nature and timing of services performed by the provider.

Supporting this allocation is even more critical in the case of success-based fees because the Transaction Cost Regulations have a substantive documentation requirement that requires a taxpayer to capitalize success-based fees unless it assembles certain documentation and does so before the due date of its return.

The Transaction Cost Regulations give some vague guidelines regarding the sufficiency of the documentation under this rule, requiring that the documentation consist of “supporting records” that are more than “merely an allocation” of time. The regulations require the documentation to identify the activities performed by the service provider, the fee amount (or percentage of time) allocable to each of the activities performed and the amount of fee (or percentage of time) allocable to activities performed before and after the bright line date. There has always been some uncertainty regarding the nature and sufficiency of the documentation required by this rule.

Summary of the Procedure & Directive

Rev. Proc. 2011-29 addresses the uncertainty of the substantive documentation requirement by permitting a taxpayer to elect to treat 70 percent of its success-based fees for a covered transaction as an amount that does not facilitate the covered transaction. The remaining 30 percent must be capitalized. This election is in lieu of the substantive documentation requirement for success-based fees described above.

A taxpayer makes this election on a transaction-by-transaction basis and must attach a statement to the original federal income tax return for the taxable year the success-based fee is paid or incurred. The statement must affirm that the taxpayer is electing the safe harbor, identify the transaction and state the success-based fee amounts that are deducted and capitalized.

The election is irrevocable and only applies to the transaction for which the election is made. Rev. Proc. 2011-29 states that an election does not constitute a change in method of accounting, hence a Sec. 481(a) adjustment is not permitted or required.

The IRS’ July 28 directive (LB&I 04-0511-012) states that Large Business & International examiners should not challenge a taxpayer’s treatment of success-based fees paid or incurred in a transaction described in Treas. Reg. Sec. 1.263(a)-5(e)(3) in taxable years ended before April 8, 2011, if the taxpayer’s original return position is consistent with Rev. Proc. 2011-29. For such fees in taxable years ended before April 8, 2011, if a taxpayer capitalizes at least 30 percent on its tax return, IRS examiners are directed not to challenge the allocation. LB&I 04-0511-012 applies only to transaction related costs paid or incurred by either an acquiring or target corporation in a covered transaction.

LB&I 04-0511-012 does not eliminate the need for documentation to substantiate the allocation of success-based fees incurred before Rev. Proc. 2011-29 is effective. Such documentation must be in place before the date the tax return is filed. Also, LB&I 04-0511-012 does not relate to attorney, accountant or other fees that are not success-based.

Analyze This

While Rev. Proc. 2011-29 and LB&I 04-0511-012 are taxpayer favorable, they do not resolve all issues regarding a taxpayer’s treatment of transaction costs. Consider:

Because Rev. Proc. 2011-29 and LB&I 04-0511-012 only address success-based fees, it is still necessary to analyze costs that are not success based, such as attorney and other non-investment banker adviser fees. Also, if an investment banker fee has non-success-based components (e.g., fairness opinion fees, milestone payments) and success-based components, Rev. Proc. 2011-29 and LB&I 04-0511-012 only apply to the success-based component. Because, depending on the case, such a bifurcation of the fee can have significant positive or negative effects that are beyond the scope of this article, a taxpayer should consider the effect of such a bifurcation when it negotiates its engagement letter with its investment banker.

While Rev. Proc. 2011-29 requires an electing taxpayer to capitalize 30 percent of its success-based fees, it does not describe the treatment of the remaining 70 percent. Accordingly, it is necessary to determine whether that 70 percent is deductible under IRC Sec. 162, amortizable over 15 years under IRC Sec. 195 or treated in another manner. Also, it may be necessary to allocate within the 70 percent portion if it consists of more than one type of service. For example, if an investment banker undertook services regarding the issuance of debt in addition to its pre-bright line date investigatory services, although it is not clear, the 70 percent portion may be allocated between borrowing services and investigatory services.

Rev. Proc. 2011-29 and LB&I 04-0511-012 do not address which entity is entitled to potential tax benefits for transaction costs when one entity incurs fees “on behalf of” a related entity. For example, if a U.S. corporation incurs fees on behalf of its non-U.S. subsidiary that undertakes the acquisition, determining whether such costs are incurred by the U.S. parent or the foreign subsidiary can have significant federal tax consequences.

Depending on the transaction’s timeline, it may be the case that more than 70 percent of a taxpayer’s fees were for pre-bright line date non-inherently facilitative services. Accordingly, before making the election under Rev. Proc. 2011-29, a taxpayer should undertake preliminary inquiries to determine whether its facts could yield a tax result more favorable than that provided by the revenue procedure. A taxpayer must weigh the risk of a challenge to the higher deduction against the certainty of Rev. Proc. 2011-29’s 70-30 allocation.

Effective Date Issues

Rev. Proc. 2011-29 applies for success-based fees incurred for taxable years ending on or after April 8, 2011. This may give different effective date results for the acquiring entity and the target. For example, if the target and acquiring corporations are on a calendar taxable year and the acquiring corporation is part of a federal consolidated group, the acquiring corporation’s 100 percent acquisition of the shares of the target for cash generally would require the target to close its taxable year at the end of the day on which the acquisition closes. The acquiring corporation’s taxable year should not close before its normal year-end.

For example, if a calendar year acquiring corporation acquired all of the stock of the target March 1, 2011, the target’s year would have closed at the end of March 1, while the acquiring corporation’s year would not close until Dec. 31. Therefore, under these facts, the target would not be able to elect under Rev. Proc. 2011-29 because the March 1 transaction occurred in a year that closed prior to April 8. On the other hand, the acquiring corporation would be able to make an election for its costs because the March 1 transaction occurred in a year that will end after April 8.

If, however, the target timely obtained documentation that 70 percent of the success-based fee it incurred was not required to be capitalized under the Transaction Cost Regulations, the target could use that information and analyze the potential deductibility of 70 percent of such success-based fees for its tax return for the taxable year ended March 1, 2011. Under the Directive, the IRS should not challenge the allocation.

Jeffrey M. Hurok is a managing director, mergers & acquisitions, tax services, with KPMG LLP in Los Angeles. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. This article represents the views of the author and does not necessarily represent the views or professional advice of KPMG LLP. John Geracimos, managing director, tax, in KPMG’s Washington National Tax practice, contributed to this article.

State-Tax Deadbeats Face Tough New Measures

2011-10-17T11:16:00.000-05:00

Here's a wake-up call for state-tax scofflaws: On Oct. 4, California Gov. Jerry Brown signed a bill requiring the Golden State's motor vehicle department to suspend the driver's licenses of its worst delinquents.

"If you don't pay your California taxes, you can't drive—we mean it," says Assembly member Henry Perea, who sponsored the bill. The suspensions will apply to those in what some call the Hall of Shame—the state's list of top tax debtors.

With the economy still reeling, California isn't alone in its quest for unpaid taxes. All states have the traditional recourse of liens and wage garnishment. But these actions are labor-intensive.

"States are looking for smarter ways to raise collections," says Verenda Smith, a researcher at the Federation of Tax Administrators.

At least 19 states, including Wisconsin, North Carolina, New York, Florida, Montana, Connecticut, Kentucky and New Jersey, follow California's approach by publishing the names of tax delinquents online, according to data from CCH, a unit of WoltersKluwer.

As states become more aggressive about collecting taxes, residents need to realize that ignoring a debt could mean public exposure or loss of a privilege.

The California driver's license suspensions will affect the state's top 1,000 tax debtors, whose names will be published online in two lists of 500 each. One list will be drawn from the income-tax rolls, with those on the second drawn from sales and other tax rolls. The new law expands an existing program by doubling the number of names on the published lists and adding the license suspensions.

California's get-tough program applies to more than driver's licenses. It also affects those for physicians, nurses, opticians and beauticians, among others. Liquor and legal licenses are a bit different: The Alcoholic Beverage Control board and state bar association will receive the tax-debtor lists and are allowed to suspend liquor and legal licenses, but they aren't required to.

What about due process? All the taxpayers listed have had liens filed against them, and they'll have at least 90 days after formal notice is issued before licenses are suspended, according to state officials. The first lists used for license suspension will be published next July, with the first suspensions beginning in October.

Mr. Perea and state tax officials are hoping the program will prod big debtors to make amends. California has had both its debtor lists since 2007, and since then the state has received over $85 million from named taxpayers.

Some of the names on the current roster are well known. Halsey Minor, a founder of CNET, is said to owe $14.2 million in income taxes. Former Playboy model and "Baywatch" star Pamela Anderson appears on the list with an income-tax debt of $607,000.

Mr. Minor disputes the amount of his debt, which he says may not take into account capital losses owed to him in a brokerage dispute currently in litigation. Ms. Anderson's tax attorney, Robert Leonard, says she has a payment agreement with the state and anticipates the liability will be resolved by the end of next year.

The total debt of all 250 taxpayers now on California's income-tax list is $152.3 million. The largest is Mr. Minor's; the smallest is $306,500.

States also are turning to special analytic programs to maximize collections. "Age is the No. 1 enemy of debt collection," says Jeff Scott, head of tax collection for Kansas. He has given state revenue agents the power to waive penalties that can amount to 30% or more of a total balance if the taxpayer agrees to settle the matter within 60 days. The offers are made on recorded phone lines, Mr. Scott says.

Kansas also avoids imposing liens whenever possible in order to avoid damaging credit scores. "We don't want to kill the credit rating and make it impossible to finance a business," Mr. Scott says. The state cooperates with neighbor Missouri as well. Many residents of one state work in the other, so Kansas has an agreement to withhold refunds to Missouri residents with home-state tax debts, and vice versa.

As a result of these and other measures, Mr. Scott says, the average recovery time for tax debts has fallen from 270 days to 74 since 2006.

Unlike California, Kansas rarely suspends professional or driver's licenses—but other states do. Iowa blocks vehicle registrations for tax debts that linger too long.

Others seem to take a tack more tailored to their population: In Minnesota, tax delinquents risk losing the ability to rent a booth at the state fair. In Louisiana, residents with tax debts greater than $500 may not be able to renew their hunting and fishing licenses.

Says Lousiana official Gary Matherne: "That really gets people's attention here."

See complete article at: http://online.wsj.com/article/SB10001424052970204774604576629442683855656.html?KEYWORDS=saunders

IRS Urges Tax Professionals to Prepare Now for New e-File Rules

2011-10-14T06:44:00.000-05:00

WASHINGTON — The Internal Revenue Service today advised tax professionals and tax firms that do not have Electronic Filing Identification Numbers (EFINs) to start the process to obtain EFINs now so they can meet new e-file requirements for 2012.
Starting in January 2012, any paid preparer or firm that reasonably anticipates preparing and filing 11 or more Form 1040 series returns, Form 1041 returns, or a combination of Form 1040 series returns and Form 1041 returns generally must use IRS e-file. Their clients who file these forms, however, may independently choose to file by paper.

To become Authorized IRS e-file Providers, preparers must create an e-Services account, submit an EFIN application and pass a suitability check. The approval process can take 45 days or more. For a firm or an individual, only one EFIN is needed.

The 2012 requirement will mark the second and final phase of implementing a law that was intended to boost the electronic filing rate of income tax returns for individuals, trusts and estates. In 2011, the e-file mandate pertained to any paid preparer or firm that anticipated preparing and filing 100 or more returns. The e-file rate by paid preparers increased 12 percent in 2011.

Currently, nearly 80 percent of individual tax returns are filed electronically. The IRS has processed more than 1 billion individual tax returns safely and securely since the nationwide debut of electronic filing in 1990.

Preparers can review the process on IRS.gov at Become an Authorized e-file Provider or find additional guidance at the Frequently Asked Questions section.

If the requirement will cause undue hardship, preparers may seek a one-year waiver by submitting Form 8944, Preparer e-file Hardship Waiver Request. If a client wants to file a paper return, the preparer should include Form 8948, Preparer Explanation for Not Filing Electronically, with the return. A taxpayer choice statement should be obtained and kept with the preparer’s records.

Form 8948 does not have to be submitted with returns that are not currently accepted electronically by the IRS or the IRS has instructed taxpayers not to file them electronically. These returns are exempt from the federal e-file requirement. Other limited exemptions may apply.

Go to the Taxpros page for more information.

IRS Updates Rules on Using Per Diem Rates to Substantiate Expenses Incurred Away from Home (Rev. Proc. 2011-47)

2011-10-05T10:10:00.000-05:00

The IRS has updated the rules for determining the amount of an employee’s ordinary and necessary business expenses for lodging, meals, and incidental expenses while traveling away from home that are deemed substantiated under Code Sec. 274(d) and Reg. §1.274-5. The guidance provides rules for using a per diem rate to substantiate lodging, meal and incidental expenses of an employee, or meal and incidental expenses only, that an employer reimburses.

If a per diem allowance is paid in lieu of reimbursement for actual lodging, meal and incidental expenses incurred by an employee for travel away from home, the amount of expenses deemed to be substantiated is the lesser of the per diem allowance for that day or the amount computed using the federal per diem rate for that locality, under §4.01. Similarly, if a per diem amount is paid for meal and incidental expenses only, the amount deemed substantiated is the lesser of the per diem allowance or the federal M&IE rate for that locality, per §4.02 and §4.03. Special rules are provided for the transportation industry in §4.04. The method for deducting incidental expenses only, without meal expenses, is provided in §4.05.

The IRS had announced its intention to discontinue the high-low substantiation method, but based on feedback received, it will continue authorization of that method. In addition, beginning with the rates for 2011-2012, the IRS will publish an annual notice containing the special per diem rates for purposes of the revenue procedure, and will update the revenue procedure only as needed, instead of annually. The high-low method may be used in lieu of the per diem method of §4.01 or the M&IE method of §4.02, with the lower of those per diem rates or the high-low rate under §5.02 being the amount deemed substantiated. The high and low rates, applicable to high-cost locations and other locations, respectively, apply as if they were federal per diem rates, and will be published in an annual notice. Under §5.03, if the high-low substantiation method is used to pay an employee, it must be used consistently for the entire year with respect to that employee.

Transition rules are set forth in §4.06 and §5.04. Special rules in §6 address the lack of necessity for a lodging receipt, situations where meals are provided in kind, proration of the relevant federal rate (regular per diem or M&IE), application of the appropriate limitation under Code Sec. 274(n), prohibition of double reimbursement or deduction, and situations where the employer and the employee are related parties. Application of the applicable rates is discussed in §7, and withholding and payment of employment taxes are covered in §8.

The revenue procedure is effective for per diem allowances for lodging, meal and incidental expenses, or M&IE expenses, that are paid to an employee on or after October 2, 2011, for travel away from home on or after that date. Rev. Proc. 2010-39, I.R.B. 2010-42, 459, is modified, amplified, and superseded.

Rev. Proc. 2011-47, 2011FED ¶46,494

Other References:

Code Sec. 162

CCH Reference – 2011FED ¶180.01

CCH Reference – 2011FED ¶1070.11

CCH Reference – 2011FED ¶8856.17

Code Sec. 274

CCH Reference – 2011FED ¶14,417.035

CCH Reference – 2011FED ¶14,417.037

CCH Reference – 2011FED ¶14,417.038

CCH Reference – 2011FED ¶14,417.039

CCH Reference – 2011FED ¶14,417.04

CCH Reference – 2011FED ¶14,417.041

CCH Reference – 2011FED ¶14,417.421

Tax Research Consultant

CCH Reference – TRC BUSEXP: 24,808

CCH Reference – TRC BUSEXP: 24,904

CCH Reference – TRC BUSEXP: 24,906.25

CCH Reference – TRC BUSEXP: 24,912.05

CCH Reference – TRC BUSEXP: 24,912.15

CCH Reference – TRC BUSEXP: 24,912.20

CCH Reference – TRC BUSEXP: 24,912.25

Tax hikes and jobs: The whole story

2011-10-05T09:42:00.000-05:00

NEW YORK (CNNMoney) -- Raise taxes on the rich, and you'll put the nation's "job creators" at risk.

It's a ubiquitous Republican talking point: Congress must keep the top two rates at 33% and 35% -- instead of 36% and 39.6% as President Obama wants.

The argument: Many small businesses file taxes under the individual tax code.

But while that argument makes for a good bumper sticker, it's a misleading simplification of a complex policy issue.

"The Republican claim that this is a tax increase on a large fraction of employers is just not true," said Howard Gleckman, a resident fellow at the Urban Institute.

In sharp contrast to the rhetoric, current data suggests small businesses don't create an outsized number of jobs, very few small business owners fall into the top two tax brackets, and tax cuts for small businesses are ineffective stimulus measures.

Relatively few small businesses would be affected: Extending the tax cuts for top earners for another decade would come at a significant cost -- nearly $1 trillion in added debt over a decade.

But small businesses wouldn't see much of that cash.

Obama's 17 tax breaks for small business: Big whoop!

Only 2.5% to 3.5% of small businesses would be affected by an increase in those two rates, according to the nonpartisan Congressional Research Service.

Instead, almost all individuals who report business income fall into lower tax brackets, where both Democrats and Republicans want to retain current rates.

And some of the businesses that do fall into the top two brackets are not what Americans typically consider "small businesses." They are doctors and lawyers and members of limited partnerships, not mom-and-pop store owners.

According to CRS, 80% of tax cuts in the top two brackets would go to non-businesses.

Small businesses are not job-creation heavyweights: It's the central premise of the argument to keep the current rates: Small businesses drive hiring. While frequently cited in political circles, it's not quite true.

First off, definitions of what exactly constitutes a small business vary greatly.

But a new report from the Treasury Department found that only 20% of small businesses in 2007 even had employees.

"It turns out most of the firms those politicians define as small businesses don't hire or invest very much at all," Gleckman wrote in a blog post on the subject.

Of course, small businesses do create a lot of jobs -- but at the same time, new ventures fail at a prodigious rate -- wiping out jobs just as fast as they are created.

According to CRS, "small businesses contribute only slightly more jobs that other firms relative to their employment share."

And a smaller, very specific, subset of that group -- startups -- drive most of the job growth. Established firms, even small ones, hire far fewer workers.

Tax cuts aren't powerful stimulus: Would an increase in tax rates mean fewer jobs are created? Maybe not.

"The primary thing standing in the way of hiring is not taxes, it's lack of demand in the economy," said Leonard Burman, a professor at Syracuse University's Maxwell School.

Would tax reform really lead to jobs?

Over the long run, most research suggests modest tax rate increases "would have little negative impact on long-term economic growth and job creation," according to CRS.

Alan Viard, a resident scholar at the conservative American Enterprise Institute, said that tax cuts do little to stimulate aggregate demand in the economy. But, he added, higher marginal rates would cut into some firms' incentive to earn additional income.

Still, the rhetoric? Unconvincing.

"Politicians have this irrational romanticization of small businesses," Viard said. "There are no economic grounds why a small firm is better than a large firm."

Read the full article at:
http://money.cnn.com/2011/10/03/news/economy/jobs_taxes/index.htm?section=money_news_economy&utm_source=feedburner&utm_medium=feed&utm_campaign=Feed%3A+rss%2Fmoney_news_economy+%28Economy+News%29

Calif. federal grand jury indicts 55 in $250 million income-tax fraud scheme

2011-10-05T09:34:00.000-05:00

By Associated Press

SANTA ANA, Calif. — The owners of two Southern California firms were among 55 people indicted by a federal grand jury in a $250 million income-tax fraud scheme claiming refunds were available through a secret government account, prosecutors and the Internal Revue Service said Monday.

The defendants also claimed the United States was bankrupt, and the country was actually owned by England.

The IRS investigation dubbed Operation Stolen Treasures targeted Fontana-based Old Quest Foundation Inc. and Rancho Cucamonga-based De la Fuente and Ramirez and Associates for filing federal income-tax returns with bogus claims for refunds.

There are 32 federal indictments, most alleging conspiracy to defraud the United States.

Hundreds of false tax returns were filed with the IRS seeking refunds. Refund checks for $5 million went out in error, IRS Special Agent Felicia McCain said Monday.

Eighteen defendants were arrested Friday and 10 defendants are fugitives or agreed to surrender Monday. Twenty-seven defendants will get a summons to appear for arraignment in coming weeks.

During presentations throughout Southern California, people falsely claiming to be attorneys, accountants and former IRS employees told potential customers that tax refunds were available through a secret government account.

Their tax defiance arguments also included claims the U.S. was penniless and Great Britain actually owned the country.

“Frivolous arguments were made by both groups,” McCain said, adding the IRS continually tries to stop such fraudulent schemes.

Those who signed up were required pay Old Quest up to $10,000 as well as a percentage of any refund they fraudulently received, authorities alleged. In exchange, Old Quest prepared and filed false income tax returns seeking huge income tax refunds, one of them for nearly $4.7 million.

When Old Quest customers received IRS letters warning that their tax returns were frivolous, members of the conspiracy prepared responses and assured customers the IRS letters were meant to intimidate them because the “IRS did not want to pay,” according to the indictments.

De la Fuente and Ramirez and Associates filed more than 35 false income tax returns seeking more than $19 million in income tax refunds, prosecutors said. The indictments said they also used seminars and one-on-one consultations to recruit customers who were each charged $2,500.

Telephone listings couldn’t be found in San Bernardino County for Old Quest Foundation Inc. and De la Fuente and Ramirez and Associates.

Read the full article at:
http://www.washingtonpost.com/business/calif-federal-grand-jury-indicts-55-in-250-million-income-tax-fraud-scheme/2011/10/03/gIQAq9fUIL_story.html

4 arrested in alleged government bribery case

2011-10-05T09:31:00.001-05:00

By ERIC TUCKER and NEDRA PICKLER - Associated Press

WASHINGTON (AP) — Two employees of the U.S. Army Corps of Engineers and two others were arrested Tuesday in a $20 million bribery and kickback case that prosecutors say helped pay for the purchase of more than a dozen properties, Rolex and Cartier watches, fancy sports cars and hotel accommodations, first-class airline tickets and a trove of other personal luxuries.

Prosecutors say the case may be one of the largest procurement fraud schemes in the nation's history.

An indictment unsealed Tuesday includes charges of bribery, conspiracy and unlawful kickbacks. The two Army Corps employees, Kerry F. Khan, a program manager, and Michael A. Alexander, a program director, received kickbacks in exchange for directing government contracts to a subcontractor specializing in software encryption devices and other information technology, prosecutors say. The men had the authority either to order products and services through government contracts or to secure funding for projects.

Also charged are Khan's son, Lee A. Khan, who prosecutors say controlled a consulting company with his father and also benefited from the scheme, and Harold F. Babb, the director of contracts for Eyak Technology LLC. Eyak Technology is a subsidiary of an Alaska native corporation with Virginia operations. It was the prime contractor for a five-year, $1 billion contract administered by the Army Corps of Engineers.

The alleged scheme, which authorities say spanned roughly four years, involved phony and inflated invoices for government contracts and millions of dollars in kickbacks that were funneled through a network of shell companies in the United States and around the world.

U.S. Attorney Ronald Machen, the top prosecutor in the District of Columbia, said at a news conference that the indictment alleges "one of the most brazen federal procurement scandals in our nation's history."

"This scheme was staggering in scope," he later said. "I think it surprised all of us."

All four defendants appeared in federal court for an arraignment a few hours after their arrest. They wore street clothes but with their feet shackled so they could only take tiny steps into the courtroom. Their attorneys entered pleas of not guilty on their behalf but said they hadn't even had time to closely read the 42-page indictment.

Prosecutors say Khan and Alexander received the kickbacks in exchange for causing the government to award contracts to a Virginia-based subcontractor identified in the indictment only as Company A and as a subcontractor for EyakTek. The company's chief technology officer, who was also not named in the indictment but is described as a co-conspirator, submitted fake and inflated invoices to the Army Corps of Engineers, either directly or through EyakTek, and the work was certified as completed, prosecutors say.

Prosecutors say the money, approximately $20 million in inflated expenses, was then funneled back to the four defendants. The Khans also agreed to transfer money to a relative imprisoned for a drug trafficking crime to prevent him from snitching on them to law enforcement, according to the indictment.

In a separate scheme that prosecutors say was halted Tuesday, the defendants allegedly conspired to steer a $780 million contract to Company A, which was going to serve as the prime contractor on an Army Corps contract.

Prosecutors say they've obtained warrants to seize funds in 29 bank accounts holding millions of dollars and are seeking to forfeit 16 properties.

All four were arrested Tuesday morning as federal agents served search warrants at more than a half-dozen locations in D.C. and Virginia. The investigation is continuing.

Prosecutors argued they should be held in jail because the 25- to 40-year maximum entences they face and their connections overseas make them a flight risk. Assistant U.S. Attorney Michael Atkinson also said Kerry and Lee Khan should be kept behind bars because they "threatened serious physical harm against a potential government witness."

The defense lawyers said the government had no reason to keep their clients behind bars, with Alexander attorney Christopher Davis arguing that his client needed to be set free to care for his cancer-stricken wife as she faces continuing chemotherapy treatments. Alexander appeared especially distraught, alternatively covering his downturned face with his hands and pinching the bridge of his nose while shaking his head.

U.S. Magistrate Judge Deborah Robinson scheduled a hearing for Thursday to decide whether the four should be detained pending trial.

A woman who picked up the phone at Kerry Khan's Alexandria home hung up on a reporter. Current phone listings for Lee Khan and Harold Babb could not immediately be found. Stephanie Alexander, Alexander's wife, told The Associated Press that her husband is a "good person" who works hard.

"I was in shock" over the arrest, she said.

Curry Graham director of public affairs for the Army Corps of Engineers, referred questions to the Justice Department but said in a phone interview: "We hold our employees to a high standard and we cooperate with all federal authorities to make sure that we get to the bottom of all these cases and allegations."

Sen. Claire McCaskill, a longtime critic of the advantage tapped by Alaska Native corporations in obtaining billions of dollars in federal contracts through a Small Business Administration program, said the charges expose problems with the "large no bid contracts that Alaska Native Corporations are allowed to enjoy at the expense of American taxpayers."

"The Alaska Native Corporations should compete for these large contracts and further should not be allowed to 'front' for other corporations that are actually doing the work," McCaskill, a Missouri Democrat and chair of the Senate Committee on Contracting Oversight, said in a written statement.

But the Native 8(a) Works coalition, which advocates for Alaska Native Corporations, said the allegations concerned just a few people and shouldn't reflect poorly on the law-abiding corporations that "provide excellent products and services to the federal government."

Read the full article at:
http://news.yahoo.com/4-arrested-alleged-government-bribery-case-144423884.html

Health care tax credits: Many left wanting

2011-09-29T10:21:00.000-05:00

By Catherine Clifford (CNN Money)

NEW YORK (CNNMoney) -- The health reform passed last year included tax credits to help ease the burden of surging health care costs for small businesses. But many small firms are ineligible.

Four million small businesses would qualify for the credit if they provide health insurance to their employees, estimates the White House Council of Economic Advisors. Of those, only 30% -- or about 1.2 million businesses -- would be eligible for the full tax credit, according to research from the Families USA and the Small Business Majority. Only the smallest companies will qualify for the maximum amount.

The tax credit refunds small businesses for a portion of the money they spend on health care premiums. However, the size of the business and the average salary can disqualify a business.

Therefore, a lot of small businesses that are struggling with the growing expense of providing their employees with health insurance don't qualify.

"We feel like we are in a doughnut hole," said Bev Hagadorn, who owns 11 Great Clips salons in the Las Vegas area with her husband, Dick. "We are a small business, but the law -- as we understand it -- doesn't treat us like a small, family-owned business," said Dick.

Dear Mr. President...

Although, they pay for employee benefits, they are ineligible for the tax credit. Their staff is too big, according to the reform law.

Bev and Dick bought their first franchise 12 years ago. They have 110 employees. Almost all of their employees work full-time. The Hagadorns offer health insurance, dental, vision, a retirement plan, and a week of vacation every six months. Managers get three weeks of vacation a year.

Benefits cost the couple about $140,000 a year and that will increase between 5% and 10% yearly.

Recently, they have had to ask employees to contribute a bit more. The Hagadorns used to pay 100% of the health care costs for their managers, but they now pay 90%.

The requirements for the tax credit: Small businesses that pay at least half of their employee's health coverage can get a significant tax refund. In what the White House claims is "broad eligibility," the maximum credit goes to businesses with 10 or fewer full-time employees with annual average wages of $25,000 or less. Companies with the equivalent of 25 full-time employees or more (the hours worked by part-timers count) or employees with annual average salaries of $50,000 or more are out of luck.

From 2010 to 2013, the tax credit is worth up to 35% of the money that a qualifying business spends on its health insurance premiums. In 2014, businesses can get a maximum of 50% of what they spend on premiums for their employees. The credit is available for a maximum of six years: 2010 through 2013 and for any two years after that.

The White House says the tax credit is doing exactly what it is supposed to do. "The tax credits were designed and targeted to the smallest businesses that often have the most difficulty offering insurance to their workers," said an administration official.

But that is of little consolation to those firms that don't qualify. "There are not too many businesses that have 25 or fewer employees -- probably real estate agents, maybe doctor offices -- but if you are a real small business, you are going to employ people," said Dick.

Sam Kumar, the owner of MYCO Medical in Cary, N.C., won't qualify for the health care tax credit, either. He only has 22 employees, but the average salary of his employees is $62,000.

Kumar spends about $60,000 a year providing health care for his employees. He pays 100% of the health care premiums for his employees and a generous suite of benefits. "And despite the fact that we have very healthy employees, our costs went up 27%," he said.

Back in 1993 when Kumar started the company with $5,000 from his 401(k), he wasn't able to pay for benefits. But now he has been able to pick up the cost for the past three years. As his business grows, he must continue to offer benefits to stay competitive.

The tax credit would help him hire.

"Right now, I have plans to hire one more person by the end of the year," said Kumar. "That could potentially be easier and could be larger had I some kind of assistance."

Regulation nightmares

"Waiting for a referee": Indeed. Rising health care costs and uncertainty about the health reform getting fully implemented have been stumbling blocks to many small business owners hiring.

For now, the Hagadorns are sitting on expansion plans. The couple has submitted applications for another six Great Clips locations and paid the down payment on those agreements. But they have yet to sign any leases with landlords.

They are still trying to figure out what the health care reform will mean for them.

"Every other sentence is if-then-but-however-and-maybe," said Dick. "And then they haven't figured this out yet. They haven't decided that yet. It is just noodle soup."

"We are waiting for the referee to decide what the rules are," he said.

Don't Cross IRS On Payroll Taxes

2011-09-29T10:16:00.000-05:00

By Robert W. Wood, Forbes

It’s tough to get out of paying payroll taxes. When you withhold tax money from employees but fail to give it to the IRS, they will come after you. Quite rightly, the IRS views it as government money, a trust fund belonging to the IRS.

In a cash-strapped business, keeping the lights on or the warehouse stocked can seem more important. It may be tempting to think you can always pay the IRS later. But these problems have a way of snowballing, so it’s best to keep payroll taxes current at all times. Consider using a payroll service that directly pays the money over to the IRS.

One more good reason to be careful?

Personal Liability. Business owners and other “responsible persons” have personal liability for these taxes and excuses are rarely accepted. In Colosimo v. U.S., the Eighth Circuit Court of Appeals refused to take sympathy on a company owner who claimed he was duped by his bookkeeper.

More recently, in Jenkins v. U.S., the Court of Federal Claims held the majority owner and CEO of a publishing company responsible for payroll taxes. Although he didn’t exercise day-to-day control, he had the authority to do so and he knew payroll taxes were unpaid. You can be liable even if have no knowledge the IRS is not being paid. See What Is The Trust Fund Recovery Penalty?

The IRS can assess a Trust Fund Recovery Assessment—also known as a 100-percent penalty—against every “responsible person.” See Section 6672(a). In determining “willfulness,” courts focus on whether you had knowledge of the non-payment of taxes or showed reckless disregard whether they were being paid. But a person need not actually perform the withholding and payment functions to be considered “responsible.”

If you have signature authority but don’t exercise it, that can be enough to result in liability. Factual nuances matter, so one person may get stuck while another gets off scot-free. The IRS often makes an assessment against every officer, watching them turn on each other.

For example, in Johnson v. U.S., the IRS went after two employees for a casino’s payroll taxes. Brian Toms was the secretary/treasurer responsible for making tax deposits and electronic transfers for payroll taxes. Bonnie Johnson was the CFO but was not a member of the board, nor an officer or shareholder. She was authorized to pay vendors in the morning before Brian arrived, but otherwise paid vendors only when Brian instructed.

Brian was held liable for the taxes but Bonnie was not. She had check-signing authority and even prepared and signed tax returns. However, she did not have control of the payroll, could not authorize tax deposits, and did not have authority to sign contracts. The court found that she did not have the authority to pay the IRS without permission from Brian.

Huge numbers of businesses each year get caught in this no-win situation. See Personal Tax Liability When A Business Goes Under. Disputes are expensive and often do not go well. Be careful out there.

Robert W. Wood practices law with Wood LLP, in San Francisco. The author of more than 30 books, including Taxation of Damage Awards & Settlement Payments (4th Ed. 2009, Tax Institute), he can be reached at Wood@WoodLLP.com. This discussion is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.

To read the full article, go to: http://www.forbes.com/sites/robertwood/2011/09/28/dont-cross-irs-on-payroll-taxes/

Justice Dept. asks high court to look at health care law

2011-09-29T10:12:00.000-05:00

By Joan Biskupic, USA TODAY

WASHINGTON – The Obama administration on Wednesday asked the Supreme Court to decide the constitutionality of a requirement that most Americans buy health insurance by 2014, paving the way for a ruling in the middle of the 2012 presidential election campaign.

Separately, 26 states and the National Federation of Independent Business, which have challenged the mandate as exceeding federal power, urged the justices to intervene and strike it down.

The new filings all but guarantee the justices will review the law that is at the heart of President Obama's domestic agenda and that has become a flashpoint in the race for Republican nomination. All the major Republican presidential candidates have vowed to overturn the law.

The justices, who open a new term on Monday, would likely act on the pending appeals this fall and hold oral arguments in early 2012.

Justice Department lawyers have appealed a decision by an Atlanta-based appeals court that said the individual-insurance mandate went beyond Congress' power to regulate interstate commerce. The lawyers say that appeals court decision, which conflicts with two appeals court rulings rejecting challenges to the law, undermines federal efforts to tackle the "crisis in the national health care market." The administration said the appeals court ruling "denies Congress the broad deference it is due … to address the nation's most pressing economic problems."

The requirement that most Americans buy insurance or face a tax penalty is the centerpiece of the health care law passed by Congress and signed by Obama in March 2010. The law was the most significant change in the nation's health care system since the creation of Medicare and Medicaid in 1965 and extends insurance coverage to 32 million Americans.

The administration says people without insurance incur billions of dollars in costs that are passed on to the insured. It contends that creates a substantial burden on interstate commerce that is within Congress' power to address.

The U.S. Court of Appeals for the 11th Circuit disagreed as it declared that forcing people to buy insurance represents an "unbounded assertion of congressional authority."

The 26 states and business group won major portions of their challenge, but the 11th Circuit rejected claims that the law's expansion of Medicaid encroaches on the states and that if the mandate is unconstitutional, the entire law is void. The states and business group have asked the justices to reverse those findings.

Is Failing To Issue IRS Forms 1099 Criminal?

2011-09-28T08:20:00.000-05:00

By Robert W. Wood, Forbes

Everyone knows something about IRS Form 1099, and if you don’t, you should. It’s that little slip of paper—barely a third of a sheet—but bearing oh-so-critical numbers: your Social Security number and how much you got paid. In that sense, a 1099 is a precursor to a tax bill.

You can look forward to getting a pile of these pesky little forms each January reporting how much each person paid you the previous year. More importantly, the IRS gets a copy of each and every one. For that reason, these Forms are all about computer matching. If you fail to report the income, the IRS will send you a bill. See Care With Forms 1099 Helps Audit-Proof Tax Returns.

If you’re in business, you probably dread these forms since issuing them is a royal pain. There are many different flavors of 1099 and many different dollar thresholds, some as low as $10 (interest). See Forms 1099 For Cost Basis: What, Me Worry? The most common, though, is $600.

If you pay someone for services in the course of your business and the payments total $600 or more during the year, you must issue the form. See Beware Each Form 1099! Since the $600 is cumulative, keep track of little payments too. There are penalties if you don’t. Rarely though, does the little old Form 1099 get mentioned in a criminal case. But where there’s a will, there’s a way.

An athletic complex in New York called Chelsea Piers is the site of adult basketball leagues where referees are paid about $40 per game. That’s not much but adds up, and you can guess where this story is headed. What if it adds up to over $600 per year? The payor must issue a Form 1099, of course.

But according to an indictment filed by the U.S. Attorney, some enterprising guys in striped outfits—referees not prison stripes—used stolen IDs to ensure they got less than $600 per year in their own names. Clever, no? Soon they may be exchanging one striped suit for another.

According to the indictment, the idea was to avoid the Forms 1099 so they could under-report their income and save at tax time. Based on stolen identification information, Chelsea Piers issued checks in many names which the defendants would (fraudulently) endorse, claim prosecutors.

Named in the indictment were: Peter Iulo, a former referee and basketball program supervisor at Chelsea Piers, and James Murray, a Chelsea Piers employee who oversaw the basketball program. Named in a separate criminal Information were two referees, Gerard Fahy, and Robert Spence.

All four were charged with conspiracy to defraud the U.S., to evade taxes, to file false tax returns, and conspiracy to commit identity theft. Several defendants were also charged with tax evasion.

No one wants to be indicted for a tax crime. Most of our tax system is voluntary and based on self-assessment. But sometimes the IRS gets tough and makes an example. My advice? Always color between the lines.

Robert W. Wood practices law with Wood LLP, in San Francisco. The author of more than 30 books, including Taxation of Damage Awards & Settlement Payments (4th Ed. 2009, Tax Institute), he can be reached at Wood@WoodLLP.com. This discussion is not intended as legal advice, and cannot be relied upon for any purpose without the services of a qualified professional.

To read the complete article, go to: http://www.forbes.com/sites/robertwood/2011/09/23/is-failing-to-issue-irs-forms-1099-criminal/

IRS Loses a Gift-Tax Battle

2011-09-28T08:17:00.000-05:00

By Laura Saunders, Wall Street Journal

Wealthy taxpayers who want to make large gifts to family members recently got good news: A federal appeals court affirmed a popular technique to sidestep gift taxes.

The decision, Estate of Petter v. Commissioner, was published in August by the Ninth Circuit in San Francisco. It joins earlier rulings on related issues by the Eighth and Fifth circuits. All the cases originated in Tax Court, but appeals go to the federal circuit court in which the taxpayer lives.

"These decisions make it easier for senior family members to transfer hard-to-value assets to heirs and charity with reduced gift-tax risk," says John Porter of Baker Botts in Houston, who argued all the cases. These and other victories have made him a rock star in the staid trust-and-estates bar.

The Internal Revenue Service declined to comment on the case.

The techniques affirmed by the Petter case are especially relevant now, says estate attorney Howard Zaritsky of Rapidan, Va. With asset values low and the estate- and gift-tax exemption slated to snap back to $1 million in 2013 from its current $5 million level, many are considering making large gifts.

But there is a hitch: valuations. These are always an issue with large gifts, especially with real estate or a business. What if the IRS challenges an estimate and wants more gift taxes? Many taxpayers are loath to write a check, and some don't have ready cash. Petter offers a solution.

Anne Petter was a Washington state teacher who died in 2008. In 1982 she inherited United Parcel Service stock from an uncle who was among the company's first investors. In May 2001, when the top gift- and estate-tax rate was 55%, she held $22 million of stock.

Estate planners advised Ms. Petter to transfer all the UPS stock to a limited-liability company. Then she both gave and sold units of the LLC to two of her children in 2002.

Why do this? In the eyes of the law, putting stock into an LLC lowers its value when units are given away or sold. That's because no one member of the LLC owns a controlling interest in it, and units can't easily be traded. This strategy also allowed Ms. Petter to retain some control. Being charitable, she also gave units to a local nonprofit with a donor-advised fund.

Ms. Petter claimed that putting the stock in the LLC entitled her to a 51% discount from its market value on the transfers made to her children. The IRS challenged that, and the two parties ultimately settled on a 36% discount.

The crux of the case: Was gift tax due once the discount dropped to 36% from 51%? Because each LLC unit had a smaller discount than Ms. Petter first assumed, it took fewer units to reach the gift-tax exemption, which was $1 million at the time. The revised discount also raised the price of the units her children bought.

As a result, some LLC units transferred by Ms. Petter weren't covered either by the gift-tax exemption or the amount her children paid her. The IRS said she owed gift tax on the transfer of these units. But she had specified that in such a case they would bounce to her IRS-registered charity—with no gift tax due.

The IRS didn't like that one bit, because it meant the penalty for an exaggerated discount was simply a donation to a charity, not a check to Uncle Sam.

"The government said if Ms. Petter prevailed, it had no incentive to audit," says Carlyn McCaffrey, an attorney at McDermott, Will & Emery in New York. The IRS's real fear, says retired tax expert Tom Ochsenschlager, is that without audits, taxpayers could "get away with murder on valuations."

The courts sided with Ms. Petter, giving a lift to taxpayers and charities, if not the IRS.

Some experts hope the decision can be broadened to include a spousal trust or perhaps a grantor-retained annuity trust benefiting heirs instead of a charity.

Others warn that the IRS has the power to change its own regulations to invalidate Ms. Petter's strategy. Mr. Zaritsky's advice: "Taxpayers interested in these transactions should do them soon."

Revenue Procedure 2011-44

2011-09-21T15:34:00.002-05:00

Revenue Procedure 2011-44 which modifies the procedures for church plans that are filing a request for a determination letter. The revenue procedure provides that plan participants and other interested parties be notified of the letter request.

Revenue Procedure 2011-44 will be in Internal Revenue Bulletin 2011-39 on Sept. 26, 2011.

IRS Notice 2011-79

2011-09-21T15:33:00.000-05:00

Notice 2011-79 explains the circumstances under which the 4-year replacement period is extended for livestock sold on account of drought. The Appendix to this notice contains a list of counties that experienced exceptional, extreme, or severe drought conditions during the 12-month period ending August 31, 2011. Taxpayers may use this list to determine if an extension is available.

Notice 2011-79 will be published in Internal Revenue Bulletin 2011-41 on Oct. 11, 2011.

IRS Announcement 2011-64

2011-09-21T15:32:00.001-05:00

Announcement 2011-64 provides notice and details regarding a new Internal Revenue Service Voluntary Classification Settlement program that provides partial relief from federal employment taxes for eligible taxpayers that agree to prospectively treat workers as employees.

Announcement 2011-64 will be published in Internal Revenue Bulletin 2011-41, dated Oct. 11, 2011.

IRS Announces New Voluntary Worker Classification Settlement Program; Past Payroll Tax Relief Provided to Employers Who Reclassify Their Workers as Employees

2011-09-21T15:30:00.000-05:00

WASHINGTON – The Internal Revenue Service today launched a new program that will enable many employers to resolve past worker classification issues and achieve certainty under the tax law at a low cost by voluntarily reclassifying their workers.

This new program will allow employers the opportunity to get into compliance by making a minimal payment covering past payroll tax obligations rather than waiting for an IRS audit.

This is part of a larger “Fresh Start” initiative at the IRS to help taxpayers and businesses address their tax responsibilities.

“This settlement program provides certainty and relief to employers in an important area,” said IRS Commissioner Doug Shulman. “This is part of a wider effort to help taxpayers and businesses to help give them a fresh start with their tax obligations.”

The new Voluntary Classification Settlement Program (VCSP) is designed to increase tax compliance and reduce burden for employers by providing greater certainty for employers, workers and the government. Under the program, eligible employers can obtain substantial relief from federal payroll taxes they may have owed for the past, if they prospectively treat workers as employees. The VCSP is available to many businesses, tax-exempt organizations and government entities that currently erroneously treat their workers or a class or group of workers as nonemployees or independent contractors, and now want to correctly treat these workers as employees.

To be eligible, an applicant must:

• Consistently have treated the workers in the past as nonemployees,

• Have filed all required Forms 1099 for the workers for the previous three years

• Not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of these workers

Interested employers can apply for the program by filing Form 8952, Application for Voluntary Classification Settlement Program, at least 60 days before they want to begin treating the workers as employees.

Employers accepted into the program will pay an amount effectively equaling just over one percent of the wages paid to the reclassified workers for the past year. No interest or penalties will be due, and the employers will not be audited on payroll taxes related to these workers for prior years. Participating employers will, for the first three years under the program, be subject to a special six-year statute of limitations, rather than the usual three years that generally applies to payroll taxes.

Full details, including FAQs, are available on the Employment Tax pages of IRS.gov, and in Announcement 2011-64, posted today.

Boehner: Debt panel can start on major tax changes

2011-09-16T10:01:00.000-05:00

By DAVID ESPO - AP Special Correspondent

WASHINGTON (AP) — House Speaker John Boehner urged Congress' deficit "supercommittee" on Thursday to lay the groundwork for a broad overhaul of the U.S. tax code, rejecting Democrats' talk of tax increases but leaving open the possibility the government's take could rise as a result.

Tax increases "are not a viable option" for the committee, Boehner declared in a speech to the Washington Economic Club, ruling out many of the proposals that President Barack Obama is expected to forward to the 12-member panel next week, including some that are part of his major jobs proposal.

Boehner made his remarks as White House officials disclosed that Obama intends to travel to Cincinnati next week as he campaigns for public support of his $447 billion proposal to cut into the nation's 9.1 percent unemployment rate. The political symbolism of the site was unmistakable — an overcrowded bridge that links Boehner's Ohio with Senate GOP leader Mitch McConnell's Kentucky, a span the president has cited as an example of the repair work his jobs program would make possible.

"We are going to run this like a campaign in the sense that we have to take it to the American people," Obama said Thursday, describing the White House strategy to donors at a political fundraiser.

"The Republicans in the House, their natural instinct right now is not to engage in the cooperation we'd like to see," he said.

Separately, White House spokesman Jay Carney said Obama will not recommend any budget savings from Social Security when he releases his recommendations to the deficit-cutting committee next week, despite the president signaling support for that idea in summertime debt-reduction talks with Boehner.

Carney declined to say what, if any, recommendations the president might make to find savings from Medicare.

The day's events underscored the extent to which the committee of 12 lawmakers is likely to be guided by the views of the most senior leaders in both political parties as it tries to develop legislation to reduce deficits by $1.2 trillion or more over a decade.

The panel has almost unlimited authority to recommend changes in federal spending and taxes and is working against a deadline of Nov. 23. It held a closed-door meeting during the day, but officials declined to provide details of what was discussed.

In his speech, Boehner was alternately critical of Obama's economic policies and somewhat conciliatory.

"Businesses are not going to hire someone for a $4,000 tax credit if government mandates impose long-term costs on them that significantly exceed the temporary credit," he said, describing a portion of what the president asked Congress to approve in his jobs program.

"Let's be honest with ourselves," he said. "The president's proposals are a poor substitute for the pro-growth policies that are needed to remove barriers to job creation in America."

The centerpiece of Obama's jobs program is a one-year extension of Social Security payroll tax cuts for workers, expanded to include businesses. He is also seeking other tax breaks, as well as an extension of unemployment benefits, aid to states to permit them to hire teachers and first responders, and construction funding for highways and bridges like the one he intends to visit in Ohio next week.

Asked whether the congressional debt panel might include some of Obama's jobs recommendations in its own work, Boehner said, "I think it's too early to determine whether some of it ends up being the work of the ... committee or whether we do it separately."

Any broad compromise that clears the bipartisan committee is almost certain to require Democratic agreement to savings from benefit programs such as Social Security and Medicare, along with Republican acquiescence to additional revenues, although any such tradeoffs are rarely discussed openly until the last possible moment in negotiations.

The committee's charter is to cut deficits, and Boehner said, "That has everything to do with jobs."

Ruling out tax increases, he said the panel has "only one option, spending cuts and entitlement reforms," a reference to government benefit programs such as Social Security, Medicare and Medicaid.

At the same time, he said the committee 'can tackle tax reform and it should." Boehner said it was probably unrealistic to expect the panel to rewrite the tax code by Nov. 23. "But it can certainty lay the groundwork by then for tax reform in the future that will enhance the environment for economic growth."

He said the elements of an eventual overhaul of the tax code would be lower rates for individuals and corporations while closing deductions, credits, and special carve-outs.

"Yes, tax reform should include closing loopholes. Not for the purposes of bringing more money to the government. But because it's the right thing," he said.

Boehner did not rule out that tax changes might result in additional government revenue, and officials in both parties say that in his talks with Obama last summer the two men were discussing the possibility that an overhaul could mean as much as an additional $800 billion for the Treasury over a decade.

At the White House, Carney said, "I would simply note that the speaker of the House made clear that in the negotiations he had with the president, he put, in his words, revenues on the table. Well, we believe revenues have to be on the table if we're going to solve our deficit and debt problems."

Similarly, in the same talks, Obama appeared willing to include a provision to slow the growth in cost-of-living increases in Social Security and to raise the age of eligibility for Medicare from 65 to 67.

Both provisions sparked strong opposition from liberal lawmakers in the president's own party, and it was not clear whether Obama has decided to rule them out of any future talks or was merely was shelving them for the time being.

The collapse last July of the talks between Obama and Boehner led to legislation that cut spending by nearly $1 trillion over a decade, averted a first-ever government default and created the debt committee that is just now beginning its work in earnest.

Associated Press writer Jim Kuhnhenn contributed to this story

12,000 tax cheats come clean under IRS program

2011-09-16T09:55:00.000-05:00

By STEPHEN OHLEMACHER - Associated Press

WASHINGTON (AP) — About 12,000 tax cheats have come clean under a program that offered reduced penalties and no jail time to people who voluntarily disclosed assets they were hiding overseas, the Internal Revenue Service announced Thursday.

Those people have so far paid $500 million in back taxes and interest. IRS Commissioner Doug Shulman said he expects the cases to yield substantially more money from penalties that have yet to be paid.

The voluntary disclosure program, which ran from February to last week, is part of a larger effort by the IRS to crack down on tax dodgers who hide assets in overseas accounts. The agency stepped up its efforts in 2009, when Swiss banking giant UBS AG agreed to pay a $780 million fine and turn over details on thousands of accounts suspected of holding undeclared assets from American customers.

Since then, the IRS has opened new enforcement offices overseas, beefed up staffing and expanded cooperation with foreign governments. A similar disclosure program in 2009 has so far netted $2.2 billion in back taxes, penalties and fines, from people with accounts in 140 countries, Shulman said.

Between the two disclosure programs, a total of 30,000 tax cheats have come clean.

"The world has clearly changed," Shulman said. "We have pierced international bank secrecy laws, and we're making a serious dent in offshore tax evasion."

The IRS has long had a policy that certain tax evaders who come forward can usually avoid jail time as long as they agree to pay back taxes, interest and hefty penalties. Drug dealers and money launderers need not apply. But if the money was earned legally, tax evaders can usually avoid criminal prosecution.

Fewer than 100 people apply for the program in a typical year, in part because the penalties can far exceed the value of the hidden account, depending on how long the account holder has evaded U.S. taxes.

The latest disclosure program offered reduced penalties, but it was no free walk. Taxpayers were required to pay up to eight years of back taxes and a penalty of up to 25 percent of the highest annual amount in the overseas account from 2003 through 2010.

The disclosure programs have also provided the IRS with information about banks and advisers who have assisted people with offshore tax evasion. Shulman said the agency will use the information to continue its enforcement efforts.

"Unlike a few years ago, it's very clear now that there's a real price to be paid for people who think they can hide offshore and not pay their taxes," he said.

IRS Notice 2011-72: Tax Treatment of Employer-Provided Cell Phones

2011-09-15T11:00:00.000-05:00

Part III - Administrative, Procedural, and Miscellaneous

Tax Treatment of Employer-Provided Cell Phones

Notice 2011-72

PURPOSE

This notice provides guidance on the tax treatment of cellular telephones or other similar telecommunications equipment (hereinafter collectively “cell phones”) that employers provide to their employees primarily for noncompensatory business purposes.

BACKGROUND

Section 2043 of the Small Business Jobs Act of 2010, Pub.L.No. 111-240, (the Act) removed cell phones from the definition of listed property for taxable years beginning after December 31, 2009. The Act did not otherwise alter the requirement that an employer-provided cell phone is a fringe benefit, the value of which must be included in the employee’s gross income, unless an exclusion applies, or the potential treatment of an employer-provided cell phone as an excludible fringe benefit. Since enactment of the Act, the IRS has received questions about the proper tax treatment of employer-provided cell phones. Accordingly, this notice addresses the treatment of employer-provided cell phones as an excludible fringe benefit.

Gross Income

Section 61 of the Internal Revenue Code (Code) defines gross income as all income, from whatever source derived. Section 61(a)(1) provides that gross income includes compensation for services, including fees, commissions, fringe benefits, and similar items. A fringe benefit provided by an employer to an employee is presumed to be income to the employee unless it is specifically excluded from gross income by another section of the Code. See Income Tax Regulations § 1.61-21(a).

Working Condition Fringe Benefits

Section 132(a)(3) of the Code provides that gross income does not include any fringe benefit which qualifies as a working condition fringe. Section 132(d) provides that “working condition fringe” means any property or services provided to an employee of the employer to the extent that, if the employee paid for such property or services, such payment would be allowable as a deduction under §§ 162 or 167.

Section 1.132-5(a)(1)(ii) of the Income Tax Regulations (Regulations) provides that if, under section 274 or any other section, certain substantiation requirements must be met in order for a deduction under §§ 162 or 167 to be allowable, then those substantiation requirements apply when determining whether a property or service is excludable as a working condition fringe. See also Regulations § 1.132-5(c)(1).

Section 162(a) of the Code provides that a deduction is allowed for all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. However, section 262(a) of the Code provides that, except as otherwise expressly provided, no deduction shall be allowed for personal, living, or family expenses.

In the case of certain listed property, as defined in section 280F(d)(4) of the Code, special heightened substantiation rules apply. Section 274(d)(4) of the Code provides that no deduction shall be allowed with respect to any listed property (as defined in § 280F(d)(4)), unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating the taxpayer’s own statement (A) the amount of such expense or other item, (B) the use of the property, (C) the business purpose of the expense or other item, and (D) the business relationship to the taxpayer of persons using the property.

The Act removed cell phones from the definition of listed property for taxable years beginning after December 31, 2009. Because the Act removed cell phones from the definition of listed property, the heightened substantiation requirements that apply to listed property no longer apply to cell phones for taxable years beginning after December 31, 2009.

De Minimis Fringe Benefits

Section 132(a)(4) of the Code provides that gross income does not include any fringe benefit which qualifies as a de minimis fringe. Section 132(e) defines a de minimis fringe as any property or service the value of which is (after taking into account the frequency with which similar fringes are provided by the employer to the employer’s employees) so small as to make accounting for it unreasonable or administratively impracticable. Except as specifically provided (i.e., occasional meal money or local transportation fare and reimbursements for public transit passes), a cash fringe benefit is not excludable as a de minimis fringe. See Regulations §1.132-6(c).

Guidance Regarding Employer-Provided Cell Phones

Many employers provide their employees with cell phones primarily for noncompensatory business reasons. The value of the business use of an employer-provided cell phone is excludable from an employee’s income as a working condition fringe to the extent that, if the employee paid for the use of the cell phone themselves, such payment would be allowable as a deduction under section 162 for the employee.

An employer will be considered to have provided an employee with a cell phone primarily for noncompensatory business purposes if there are substantial reasons relating to the employer’s business, other than providing compensation to the employee, for providing the employee with a cell phone. For example, the employer’s need to contact the employee at all times for work-related emergencies, the employer’s requirement that the employee be available to speak with clients at times when the employee is away from the office, and the employee’s need to speak with clients located in other time zones at times outside of the employee’s normal work day are possible substantial noncompensatory business reasons. A cell phone provided to promote the morale or good will of an employee, to attract a prospective employee or as a means of furnishing additional compensation to an employee is not provided primarily for noncompensatory business purposes.

This notice provides that, when an employer provides an employee with a cell phone primarily for noncompensatory business reasons, the IRS will treat the employee’s use of the cell phone for reasons related to the employer’s trade or business as a working condition fringe benefit, the value of which is excludable from the employee’s income and, solely for purposes of determining whether the working condition fringe benefit provision in section 132(d) applies, the substantiation requirements that the employee would have to meet in order for a deduction under §162 to be allowable are deemed to be satisfied. In addition, the IRS will treat the value of any personal use of a cell phone provided by the employer primarily for noncompensatory business purposes as excludable from the employee’s income as a de minimis fringe benefit. The rules of this notice apply to any use of an employer-provided cell phone occurring after December 31, 2009. The application of the working condition and de minimis fringe benefit exclusions under this notice apply solely to employer-provided cell phones and should not be interpreted as applying to other fringe benefits.

EFFECTIVE DATE

This notice is effective for all taxable years after December 31, 2009.

CONTACT INFORMATION

The principal author of this notice is Joseph Perera of the Office of Associate Chief Counsel (Tax Exempt & Government Entities). For further information regarding this notice contact Joseph Perera on (202) 622-6040 (not a toll-free call).

Hedge Fund Fair Tax Can Cut Deficit By $18 Billion

2011-09-15T10:54:00.000-05:00

By Peter Cohan

President Obama suggested that we help finance the American Jobs Act, in small part, by asking hedge funds to pay what I think is a fair tax. And if they do, the budget deficit will drop by $18 billion.

The proposed tax change would require hedge funds to pay an ordinary income tax rate (35%) instead of the current capital gains rate (15%) on their so-called carried interest. Carried interest is the money that hedge fund managers get paid as a reward for making profits on their fund’s investments.

Hedge funds typically get paid through a combination of management fees and carried interest. For a hedge fund managing $5 billion, the management fees might be $100 million a year (2% of the assets under management). And if the hedge fund returned 10% — adding $500 million to the value of that asset pile, the fund’s investors would get $400 million (80%) and the hedge fund managers’ carried interest would total $100 million (20%).

Currently that $100 million is taxed at 15%. To understand why it should be taxed at 35%, it helps to understand the rationale for setting the capital gains rate below that of ordinary income. As I discussed on CNBC with the Wall Street Journal’s Alan Murray back in 2007, we want to encourage putting capital at risk so we tax the gains from such risk at a lower rate.

The reason that raising that rate for hedge fund managers is fair, in my opinion, is because the money that hedge funds invest is partially that of the hedge fund managers themselves and mostly that of the hedge fund’s investors. The hedge fund manager should not be rewarded with a lower tax rate for putting someone else’s money at risk.

Simply put, carried interest is a blend of at risk and not at risk profits, so it should be taxed in a blended way. To the extent that a general partner is putting his or her own capital at risk in a deal, then the carried interest in that deal should be taxed as a capital gain.

However, to the extent that the general partner is putting the limited partners’ capital at risk, the pro-rata share of the carried interest should be taxed to the general partner at the ordinary income rate.

Simply put, since general partners put very little of their own money at risk, most of the carried interest is really a fee for managing other people’s money and that fee should be taxed at the ordinary income rate. After all, any income that is part of regular trade or business normally is taxed at ordinary tax rates. And for most hedge funds, profiting with other peoples’ money is a regular occurrence.

How well will this argument go over in Washington? If money buys votes, then the answer as of April 2011 is pretty simple — like a lead balloon. That’s because according to the Center for Responsive Politics, hedge funds have shifted the lion’s share of their money from the Democratic Party to the Republicans. Specifically, in 2008 hedge funds gave $12 million to Democrats and $7 million to Republicans but by 2010 the split had shifted to $4.5 million for the Democrats and $13 million for the Republicans.

I’d challenge a hedge fund manager to defend the idea that it’s as risky for them to put a client’s money into a trade as it is to bet their own cash. It doesn’t seem defensible to me though. After all, if the client loses money on a trade, that doesn’t cost the hedge fund manager much beyond the client’s frustration. It’s only when he loses his own money, that he feels the burn in his own bank account.

Being a hedge fund manager is the world’s most lucrative job — in 2010, the nine highest paid made over $1 billion personally. If hedge funds paid a fair tax, their managers would still be the highest paid people in the world.

Even if a few people did drop out of the hedge fund industry because they had to pay a 35% tax rate on their profits, do hedge funds really create so much value for society that those drop-outs would be missed?

Read the full article here: http://www.forbes.com/sites/petercohan/2011/09/14/hedge-fund-fair-tax-can-cut-deficit-by-18-billion/

Final Regs. Governing Practice Before the IRS

2011-09-06T13:58:00.000-05:00

by Jordan Adams, CPA, and Karen Galvin, CPA, Oak Brook, IL

Procedure & Administration

On May 31, 2011, Treasury issued final regulations governing practice before the IRS to increase taxpayer compliance and to ensure uniform and high ethical standards of conduct for all tax return preparers (T.D. 9527). The final regulations, which became effective August 2, 2011, amend Circular 230, Regulations Governing the Practice of Attorneys, Certified Public Accountants, Enrolled Agents, Enrolled Actuaries, Enrolled Retirement Plan Agents, and Appraisers Before the Internal Revenue Service (31 C.F.R. Part 10). The new rules create a new class of practitioner called a registered tax return preparer. They also revise the professional standards applicable to all practitioners with respect to the standards for tax return preparation under Circular 230, Section 10.34(a), to align these rules with the civil penalty standards under Sec. 6694(a). In addition, the final regulations provide guidance surrounding incompetence and disreputable conduct by tax return preparers.

Background

In June 2009, the IRS initiated a review of tax return preparers with the intent to both increase taxpayer compliance and propose a comprehensive set of recommendations to ensure uniform and high ethical standards of conduct for all tax return preparers. As part of the industry review, the IRS received input through public forums, solicitation of written comments, and meetings with advisory groups. An overwhelming number of commentators supported increased government oversight of tax return preparers, particularly for individuals who are not attorneys, CPAs, or others currently authorized to practice before the IRS. They believed that taxpayers, the IRS, and tax administration would all benefit from the registration of tax return preparers. In addition, the commentators favored minimum education or testing requirements and the establishment of quality and ethics standards for paid tax return preparers. The IRS reported the findings and recommendations of its review in Publication 4832, Return Preparer Review (December 2009), which it released on January 4, 2010. The report recommends increased oversight of the tax return preparer industry through the issuance of regulations.

To implement recommendations made in the report, in September 2010 the IRS issued final regulations under Sec. 6109 that require all individuals who prepare tax returns to register with the IRS and to obtain a preparer tax identification number (PTIN). The tax return preparer must furnish the PTIN when he or she signs a tax return or claim for refund. The PTIN registration mandate is expected to improve the accuracy, completeness, and timeliness of tax returns. The IRS will be able to match preparers with the tax returns and claims for refund that they prepare, which will help the IRS with oversight of tax return preparers and with administration of requirements intended to ensure that tax return preparers are competent, trained, and conform to rules of practice.

To further implement the recommendations made in the report, the IRS issued proposed Circular 230 regulations (REG-138637-07) that were finalized on May 31, 2011. The final regulations create a new class of practitioner and provide standards for all tax return preparers that align with the tax preparer penalty provisions under Sec. 6694.

Registered Tax Return Preparers

Under prior regulations, tax return preparers generally were not subject to the provisions of Circular 230 unless the preparer was a CPA, attorney, or enrolled agent. Prior to the issuance of the final regulations, any individual could prepare tax returns and claims for refund without meeting specific qualifications or competency standards. The final regulations adopt the proposed amendments to Circular 230, Section 10.3(f), and establish the new designation of registered tax return preparer. A registered tax return preparer is any individual so designated under Circular 230, Section 10.4(c)—that is, who is 18 years old or older, has passed an IRS administered competency exam, possesses a current PTIN, and is not currently under suspension or disbarment from practice before the IRS. CPAs, attorneys, and enrolled agents are not registered tax return preparers.

The final regulations provide that practice as a registered tax return preparer is limited to preparing and signing tax returns, claims for refund, and other documents for submission to the IRS (Circular 230, §10.3(f)(2)). The new rules state that the IRS will prescribe the tax returns and claims for refund that a registered tax return preparer may prepare and sign.

Registered tax return preparers may represent taxpayers before revenue agents, customer service representatives, and similar officers and employees of the IRS (including the Taxpayer Advocate Service) during an examination if the preparer signed the tax return or claim for refund for the tax year or period under examination (Circular 230, §10.3(f)(3)). However, registered tax return preparers may not represent taxpayers before appeals officers, revenue officers, counsel, or other similar officers or employees of the IRS or Treasury.

In addition, a registered tax return preparer’s authorization to practice does not include the authority to provide tax advice to a client or another person except as necessary to prepare a tax return, claim for refund, or other document intended to be submitted to the IRS. The preamble to the final regulations provides that Treasury and the IRS have concluded that the federally authorized tax practitioner privilege generally does not apply to communications between a taxpayer and a registered tax return preparer because the advice the preparer provides is ordinarily intended to be reflected on a tax return and is not intended to be confidential or privileged. (The privilege under Sec. 7525 does not extend to documents and communications used in tax return preparation.) The conduct of a registered tax return preparer in connection with the preparation of the return, claim for refund, or other document, as well as any representation of the client during an examination, will be subject to the standards of conduct in Circular 230. Inquiries into possible misconduct and disciplinary proceedings relating to registered tax return preparer misconduct will be conducted under the provisions in Circular 230.

Circular 230, Section 10.5, prescribes the applicable procedures for becoming a registered tax return preparer, which are generally consistent with the procedures currently used for enrolled agents and enrolled retirement plan agents. An individual who wants to become a registered tax return preparer or to renew his or her designation as such must use forms and comply with the procedures established and published by the IRS. As a condition for consideration of an application, the IRS may conduct a federal tax compliance check and a suitability check. The tax compliance check will be limited to an inquiry about whether the individual has filed all required individual or business tax returns and has paid or made proper arrangements with the IRS for payment of any federal tax debts. The suitability check will be limited to an inquiry about whether the individual has engaged in any conduct that would justify suspension or disbarment of a practitioner, including whether the applicant has engaged in disreputable conduct.

In addition to the compliance and suitability checks, a registered tax return preparer must pass a competency examination and possess a valid PTIN. Notice 2011-45, which the IRS released to accompany the final regulations, provides that during the time period before the competency examination is available and the compliance and suitability checks are final, individuals with a provisional PTIN may not represent themselves as registered tax return preparers. Only individuals who have met all the conditions, including passing the examination and the compliance and suitability checks, may represent that they are registered tax return preparers.

To qualify for renewal as a registered tax return preparer in subsequent years, an individual must complete a minimum of 15 hours of continuing education credit, including 2 hours of ethics or professional conduct, 3 hours of federal tax law updates, and 10 hours of federal tax law topics during each registration year (Circular 230, §10.6(e)(3)). A registration year includes each 12-month period the registered tax return preparer is authorized to practice before the IRS. The registered tax return preparer must maintain records related to the completion of the continuing education credit hours for a period of four years following the renewal date.

To qualify for continuing education credit, a course must be designed to enhance professional knowledge in federal taxation or federal tax-related matters and must be consistent with the Code and effective tax administration (Circular 230, §10.6(f)). The maximum continuing education credit allowed for instruction and preparation is four hours annually. No continuing education credit hours are allowed for authoring articles, books, or other publications.

Standards with Respect to Tax Returns

In addition to the rules for registered tax return preparers, the Circular 230 standards under Section 10.34(a), which apply to all practitioners, were updated to be consistent with the tax return preparer civil penalty standards under Sec. 6694. Since the professional standards included in Circular 230 were not aligned with the Sec. 6694 tax return preparer penalty standards, some commentators on the proposed Circular 230 regulations were concerned that a violation of Sec. 6694 would translate to a per se violation of Section 10.34. The final regulations indicate that a practitioner liable for a penalty under Sec. 6694 is not automatically subject to discipline under Circular 230, Section 10.34(a).

The final regulations provide that a practitioner may not willfully, recklessly, or through gross incompetence sign a tax return or claim for refund that the practitioner knows or reasonably should know contains a position that:

* Lacks a reasonable basis;

* Is an unreasonable position as described in Sec. 6694(a)(2) (including the related regulations and other published guidance); or

* Is a willful attempt by the practitioner to understate the liability for tax or a reckless or intentional disregard of rules or regulations as described in Sec. 6694(b)(2) (including the related regulations and other published guidance).

A practitioner may not willfully, recklessly, or through gross incompetence advise a client to take a position on a tax return or claim for refund containing a position as described in the three points above. In addition, the practitioner may not prepare a portion of a tax return or claim for refund containing a position described above.

The final regulations also provide guidance on incompetence and disreputable conduct by tax preparers. Section 10.51 of Circular 230 defines disreputable conduct for which a practitioner may be sanctioned and includes the following scenarios under which such standards are applicable. Sec. 6011(e)(3) requires certain specified tax return preparers to file individual income tax returns electronically. Treasury and the IRS believe that the failure to comply with this requirement is disreputable conduct. Accordingly, Circular 230, Section 10.51(a)(16), as finalized provides that disreputable conduct includes willfully failing to file on magnetic or other electronic media a tax return prepared by the practitioner when the practitioner is required to do so by federal tax laws unless the failure is due to reasonable cause and not willful neglect. Under Section 10.51(a)(17), disreputable conduct includes willfully preparing all or substantially all of, or signing, a tax return or claim for refund when the practitioner does not possess a current or otherwise valid PTIN or other prescribed identifying number. Section 10.51(a)(18) prescribes that willfully representing a taxpayer before an officer or employee of the IRS unless the practitioner is authorized to do so under Circular 230 is disreputable conduct. These standards generally apply to all tax return preparers and come as a result of feedback to ensure ethical conduct by those in the profession.

Conclusion

Over the years, the IRS has implemented several tax return preparer standards with the intent of increasing taxpayer compliance and ensuring uniform and high ethical standards of conduct for all tax return preparers. The new rules regarding registered tax return preparers and the standards on tax return preparation are further attempts by the IRS to enhance these professional standards and will continue to affect the tax profession for years to come.

Transaction Cost Considerations: Rev. Proc. 2011-29 and Other Related Matters

2011-09-06T13:45:00.000-05:00

by Matthew J. Mittman, CPA, Oak Brook, IL, and Thomas J. Brecht, CPA, Elkhart, IN

Expenses & Deductions

The treatment of success-based fees that are paid or incurred in connection with the successful closing of business acquisitions or reorganizations described in Regs. Sec. 1.263(a)-5(e)(3) (covered transactions) continues to be the subject of controversy between the IRS and taxpayers. Specifically, numerous disagreements have arisen regarding what documentation is necessary to establish that a portion of the success-based fee is allocable to activities that do not facilitate a business acquisition, which could result in an immediate deduction to the taxpayer.

In an effort to eliminate the controversy over the allocation of success-based fees and corresponding documentation requirements, the IRS issued Rev. Proc. 2011-29, providing taxpayers with a safe-harbor election for allocating 70% of success-based fees paid or incurred in a covered transaction described in Regs. Sec. 1.263(a)-5(e)(3) to activities that do not facilitate the transaction. The remaining 30% of the success-based fees must be capitalized as an amount that facilitates the transaction. The election is available for success-based fees paid or incurred in tax years ending on or after April 8, 2011.

Taxpayers that choose not to make the election must maintain documentation under Regs. Sec. 1.263(a)-5(f) to establish that a portion of the success-based fees are allocable to activities that do not facilitate the transaction. As addressed below, the safe-harbor election under the revenue procedure attempts to eliminate the controversy over the allocation of success-based fees and the documentation requirements for only certain transactions.

Background

Under Sec. 263(a)(1) and Regs. Sec. 1.263(a)-2(a), capitalization is required and no immediate deduction is allowed for any amount paid for property that has a useful life substantially beyond the tax year of the taxpayer. In the case of an acquisition or reorganization of a business entity, acquisition costs that generate significant long-term benefits must be capitalized.

Under Regs. Sec. 1.263(a)-5, a taxpayer must capitalize amounts paid that facilitate transactions, including business acquisitions and reorganizations, described in Regs. Sec. 1.263(a)-5(a). An amount paid or incurred in the process of investigating or otherwise pursuing the transaction is an amount paid to facilitate a transaction described in Regs. Sec. 1.263(a)-5(a), unless the services were performed prior to the date the letter of intent was signed or the material terms of the transaction were agreed to by representatives of the acquirer and the target (this date is referred to as the bright-line date and is described in Regs. Sec. 1.263-5(e)(1)). (See Regs. Sec. 1.263-5(e)(2) for exceptions to Regs. Sec. 1.263-5(e)(1).)

A success-based fee paid or incurred on the closing of a transaction described in Regs. Sec. 1.263(a)-5(a) is presumed to facilitate the transaction under Regs. Sec. 1.263(a)-5(f). To rebut the presumption that a success-based fee paid or incurred is facilitative of a covered transaction, the taxpayer must maintain sufficient documentation in accordance with Regs. Sec. 1.263(a)-5(f). Covered transactions under 1.263(a)-5(e)(3) consist of:

* A taxable acquisition by the taxpayer of assets that constitute a trade or business;

* A taxable acquisition of an ownership interest in a business entity (whether the taxpayer is the acquirer or the target in the acquisition) if, immediately after the acquisition, the acquirer and the target are related within the meaning of Sec. 267(b) or 707(b); and

* A reorganization described in Sec. 368(a)(1)(A), (B), or (C) or one described in Sec. 368(a)(1)(D) in which stock or securities of the corporation to which the assets are transferred are distributed in a transaction that qualifies under Sec. 354 or 356 (whether the taxpayer is the acquirer or the target in the reorganization).

The IRS and Treasury expect that much of the controversy surrounding the treatment of success-based fees and the type and extent of documentation required to establish that a portion of a success-based fee is allocable to activities that do not facilitate a covered transaction can be eliminated by giving taxpayers a simplified method for allocating a success-based fee paid in a covered transaction. Accordingly, Rev. Proc. 2011-29 provides a safe harbor for allocating a success-based fee between activities that facilitate a covered transaction and activities that do not facilitate a covered transaction.

Making the Safe-Harbor Election and Its Impact

Instead of taxpayers having to maintain the documentation required under Regs. Sec. 1.263(a)-5(f) to substantiate the allocation of success-based fees between activities that facilitate and those that do not facilitate a covered transaction described in Regs. Sec. 1.263(a)-5(e)(3), the IRS will not challenge the taxpayer’s allocation of a success-based fee if the taxpayer:

* Treats 70% of the amount of the success-based fee as an amount that does not facilitate the transaction;

* Capitalizes the remaining 30% as an amount that does facilitate the transaction; and

* Attaches a statement to its original federal income tax return for the tax year the success-based fee is paid or incurred, stating that the taxpayer is electing the safe harbor, identifying the transaction, and stating the success-based fee amounts that are deducted and capitalized.

The 70% of the success-based fees that is treated as not facilitative of the transaction is essentially treated the same as nonfacilitative costs incurred prior to the bright-line date would have been had the taxpayer completed an analysis and allocation of the actual time incurred.

An election under Rev. Proc. 2011-29 is irrevocable and applies only with respect to all success-based fees paid or incurred by the taxpayer in the transaction for which the election is made. An election for any acceptable transaction generally does not constitute a change in the taxpayer’s method of accounting for success-based fees. Accordingly, a Sec. 481(a) adjustment is neither permitted nor required.

Immediate Deduction or Start-up Cost

If the purchasing entity (Purchaser) acquires the corporate stock of a target entity (Target) or the assets that constitute the trade or business of Target in a covered transaction under Regs. Secs. 1.263(a)-5(c)(3)(i) and (ii), and Purchaser is currently in the same line of trade or business as Target, the portion of expenses that are not facilitative of the transaction is immediately deductible by Purchaser under Sec. 162 as an ordinary business expense. Accordingly, a safe-harbor election under Rev. Proc. 2011-29 can result in an immediate deduction for 70% of the success-based fees paid by Purchaser. If Purchaser is not in the same trade or business as Target, the costs incurred that are not facilitative of the transaction, including 70% of the success-based fee, are deductible as they are amortized under Sec. 195.

In the acquisition of Target’s stock or assets that constitute the trade or business of Target (asset acquisition) by a non-strategic buyer, such as a private equity group, Purchaser is commonly a newly formed corporate entity (Newco). If Target is an add-on to one of the private equity group’s existing portfolio companies, and Newco acquires the stock or assets of Target and makes the safe-harbor election under the revenue procedure, 70% of the success-based fee paid by Newco is not facilitative of the covered transaction. However, as explained below, the portion of the success-based fee that is not facilitative of the transaction is not immediately deductible by Newco.

In Specialty Restaurants Corp., T.C. Memo. 1992-221, the Tax Court held that a parent corporation could not deduct the start-up expenses of subsidiaries incorporated to open and operate theme restaurants as Sec. 162 business expenses because the restaurants had not been opened and therefore the expenses were not related to trade or business. The amounts paid should have been either capitalized under Sec. 263 or amortized under Sec. 195. Accordingly, 70% of the success-based fee paid by Newco is not immediately deductible under Sec. 162 as an ordinary business expense but instead is a start-up expense subject to Sec. 195.

Bargain Purchase

If Purchaser acquires Target in an asset acquisition, the costs that facilitate the transaction are capitalized and allocated to the basis of the acquired assets under Regs. Sec. 1.263(a)-5(g)(2)(i). As discussed above, an election made by Purchaser under Rev. Proc. 2011-39 to treat 70% of the success-based fee paid as nonfacilitative of the transaction results in an immediate deduction if Purchaser is currently in the same line of trade or business as Target. If Purchaser is not in the same line of trade or business as Target, the nonfacilitative costs are subject to Sec. 195.

In the case of a bargain purchase (an asset acquisition where total purchase consideration—i.e., amounts paid plus liabilities assumed—is less than the fair market value (FMV) of Target’s assets), Purchaser might recognize income immediately after the transaction. For example, if, after allocating total purchase consideration in accordance with Sec. 1060(a) and Regs. Sec. 1.338-8(b), Purchaser’s tax basis in acquired inventory is less than its FMV and Purchaser subsequently sells the inventory, Purchaser has taxable income equal to the difference between the sales price and tax basis of the inventory. When there is a bargain purchase of Target and Purchaser is not in the same line or business as Target, the amount of the success-based fee that is not facilitative of the transaction under the revenue procedure is a start-up cost under Sec. 195. If the amount of nonfacilitative costs exceeds the annual deduction allowed under Sec. 195, Purchaser will obtain a tax benefit for this amount over a period of 15 years. However, if Purchaser does not make the safe-harbor election under the revenue procedure, the entire success-based fee is allocated to the assets acquired as discussed above. Accordingly, Purchaser will realize a tax benefit for the amount of the fee paid in the first tax year subsequent to the transaction, assuming the entire success-based fee is allocated to the acquired inventory and all inventory is sold shortly thereafter.

Legal and Other Fees

Rev. Proc. 2011-29 appears to apply only to success-based fees paid or incurred in a covered transaction. However, Purchaser typically incurs legal, accounting, and consulting fees that are not success based in conjunction with a covered transaction. If Purchaser does not want to capitalize the other costs incurred into either the stock basis of Target or the basis of Target’s assets, Purchaser must analyze the various costs paid or incurred in the transaction to determine which amounts are not facilitative of the transaction and are immediately deductible as Sec. 162 normal business expenses, or subject to Sec. 195.

Success-Based Fees Allocable to Debt Issuance Costs

In business acquisitions by private equity groups, Newco’s purchase of Target’s stock or assets is typically funded by new borrowings and capital equity. Many private equity groups also charge a success-based fee upon the close of the business acquisition, of which a portion is attributable to the time spent in obtaining the financing. Based on Regs. Sec. 1.263(a)-5, the amount of a private equity group’s success-based fee that is allocated to debt issuance costs and amortized under Regs. Sec. 1.446-5 is determined by the percentage of the private equity group’s time spent arranging the financing.

Under Regs. Sec. 1.263(a)-5(c)(1), an amount paid to facilitate a borrowing is not facilitative of another transaction that is described under Regs. Sec. 1.263(a)-5(a). Accordingly, a private equity group that obtains financing to fund the purchase of Target’s stock or assets has two separate transactions identified under Regs. Sec. 1.263(a)-5(a). However, a success-based fee paid to the private equity group is related to the successful closing of both transactions, which are integrally related to the private equity group.

As discussed above, the election under Rev. Proc. 2011-29 is available only to covered transactions. However, a transaction that constitutes a borrowing is not one of the covered transactions listed under Regs. Sec. 1.263(a)-5(e)(3). As such, it appears that the safe-harbor election under the revenue procedure does not apply to the allocation of a success-based fee to debt issuance costs.

There is some uncertainty in this interpretation, though as the revenue procedure also states, “[t]he election applies with respect to all success-based fees paid or incurred by the taxpayer in the transaction for which the election is made” (Rev. Proc. 2011-29, §4.02; emphasis added). It appears that the reference to the transaction within the revenue procedure is to a covered transaction. The plain language seems to indicate that a borrowing that takes place in conjunction with a covered transaction is a separate and distinct transaction. Consequently, it appears that the costs associated with the borrowing are not includible in the revenue procedure election.

If the success-based fee allocated to the financing transaction is not subject to Rev. Proc. 2011-29, presumably it is reasonable for the taxpayer to first allocate the fee between the debt issuance costs and the covered transaction, then make the safe-harbor election under the revenue procedure for the portion of the success-based fee allocated to the covered transaction. Accordingly, the taxpayer could end up with the ability to capture a larger portion of the overall success-based fee paid through amortization or immediate deduction. However, the taxpayer must obtain proper documentation to substantiate the allocation of success-based fees paid to the debt origination and the covered transaction, which defeats the purpose of the revenue procedure. The IRS needs to provide further clarification to confirm this understanding.

Conclusion

It is important to consider that the election under Rev. Proc. 2011-29 is available to success-based fees paid or incurred (including the sell-side costs, which this item does not explicitly address) in a covered transaction. Generally, costs incurred in a transaction that a taxpayer is not required to capitalize under Regs. Sec. 1.263(a) or Sec. 195 are deductible as ordinary and necessary expenses. As a result, it is important to analyze the timeline of the transaction and determine the bright-line date when considering whether to make the election under the revenue procedure. If more than 70% of the activities that generated the success-based fee occurred prior to the bright-line date, the election might not be beneficial. The tax benefit might be larger in specific fact patterns when making the election under the revenue procedure; however, the net present value of the tax benefit might still be larger without making the election due to the timing of the resulting deductions. One must consider both the amount and the timing of the deductions with and without the election. Further clarification is needed from the IRS regarding the application of Rev. Proc. 2011-29 to a success-based fee paid or incurred in a transaction that is composed of both a debt issuance and a covered transaction, as commonly encountered by private equity groups.

Unclaimed Property: The Nontax State Revenue Generator

2011-09-06T13:41:00.000-05:00

by Angela R. Gebert, CPA, Fort Wayne, IN (formerly with Crowe Horwath LLP), and Chris Hopkins, CPA, New York, NY

Miscellaneous

Why should tax professionals care about unclaimed property? After all, unclaimed property is not a tax but a property right. However, unclaimed property looks and acts very much like a tax. In fact, similarities can cause compliance responsibilities and audit notices to drop squarely in the lap of a tax practitioner. To recognize the issues and potential risks, the fundamentals of unclaimed property need to be understood.

Background

Unclaimed property, also known as abandoned property, consists of property held or owing in the ordinary course of business that the owner has not claimed for a certain period of time (the dormancy period). All 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, and Guam, as well as a handful of foreign countries, have enacted unclaimed property laws. Unclaimed property can include uncashed payroll and vendor checks, accounts receivable credit balances, dormant bank and brokerage accounts, life insurance policies, gift certificates and gift cards, customer refunds and rebates, publicly traded securities, benefit plan payments, and the contents of safe deposit boxes. While unclaimed property or escheat laws date back to the Middle Ages, aggressive compliance enforcement by states is a relatively recent phenomenon. When dealing with the state taxes, tax practitioners think in terms of physical presence, nexus, and equitable apportionment. But since unclaimed property is technically not a tax, these concepts generally do not apply.

The Supreme Court established the jurisdictional rules for states claiming property in the 1965 case Texas v. New Jersey, 379 U.S. 674 (1965). The priority rules are:

* The jurisdiction of the owner’s last known address as reflected in the holder’s records is entitled to custody of the unclaimed property; and

* If the owner’s last address is unknown, the jurisdiction in which the holder is domiciled (incorporated) is entitled to claim the unclaimed property.

As discussed below, liberal interpretations of the second rule by some states create the biggest challenge—and potential liability—for many companies. A number of states have also adopted a third-priority or “throwback” rule. Under this rule, if there is no owner address and the holder’s state of domicile does not have unclaimed property laws that apply to the property, the state in which the transaction giving rise to the property occurred may claim the property. The Supreme Court has not sanctioned the third-priority rule.

Current Economic Climate and Trends

Due to the current economic environment and the budgetary problems of many states, unclaimed property is turning into what amounts to a tax—or at least a means to fill depleted state coffers. A number of states now view unclaimed property enforcement as a politically neutral, no-cost revenue generator and participate in multistate audits conducted by contract audit firms.

Some unclaimed property administrators have expanded the definition of what constitutes unclaimed property, leading to new and sometimes creative types of property being subject to state claim. Increased legislative activity has also resulted in the enactment of shorter statutory dormancy periods. While dormancy periods were historically often 7–15 years, dormancy periods of three years or less are becoming the norm. The purported rationale for the shorter dormancy periods is to more quickly reunite property with owners, but the reality is that they accelerate states’ receipt of funds.

While the purpose and intent of the unclaimed property laws in most states is to reunite lost property with owners, cash-strapped states sometimes lose sight of this objective. In 2007, a U.S. appeals court effectively enjoined the state of California from taking unclaimed property due to inadequate efforts by the state to return property to owners (Taylor v. Westly, 488 F.3d 1197 (9th Cir. 2007)). After the state tightened its custodial safekeeping practices, the order was lifted.

In 2009, a U.S. district court ruled in favor of an issuer of traveler’s checks after the Kentucky legislature attempted to shorten the dormancy period for uncashed traveler’s checks from 15 to 7 years (American Express Travel Related Servs. v. Hollenbach, 630 F. Supp. 2d 757 (E.D. Ky. 2009), vacated and remanded, No. 09-5898 (6th Cir. 5/5/11)). The court concluded that the legislative change was “arbitrary and capricious and violate[d] the Due Process Clause of the United States Constitution.” However, the Sixth Circuit disagreed and held that the amendment does not violate the Due Process Clause.

On January 31, 2011, the Third Circuit issued a temporary injunction against New Jersey’s statutory requirement that stored value card issuers obtain and maintain a record of the zip code of stored value card purchasers (American Express Travel Related Servs. v. Sidamon-Eristoff, No. 11-1141 (3d Cir. 1/31/11)). The law, which included a presumption that the place of a card’s sale or issuance was the purchaser’s address if the purchaser’s name and address were not known, was a not-so-subtle attempt by the state to collect unredeemed stored value card balances. Notwithstanding these and other decisions, states continue to increase enforcement efforts to shore up budget gaps. Along with this increased enforcement comes significant audit exposure and financial risk.

Traditional Taxes Versus Unclaimed Property

While traditional state taxes and unclaimed property both serve as revenue generators for states, there are some significant differences that are important to recognize. In addition to tax nexus rules and equitable methodologies for apportionment not applying to unclaimed property, most states have no or limited statutes of limitation. Even companies that have a long history of compliance may be shocked to find that an unclaimed property audit can cover a period of up to 25 years. And although no state provides written rules for estimating a liability when a holder’s records are “incomplete,” there are limited or no rights for holders to administratively challenge assessments that seem unreasonable or egregious. Another significant difference is that contract auditors, not state employees, usually perform unclaimed property audits. States typically compensate contract audit firms on a commission or contingent fee basis, creating an incentive for such firms to propose very large assessments.

A major factor in the discrepancy between money collected by states on audit and money returned to owners is the fact that estimation techniques are often used to determine a holder’s liability. An estimated liability is outright revenue for a state since there is no owner to whom the state can return the property. A company needs to change its approach when considering unclaimed property issues. Unlike traditional taxes, where liability generally relates to the geographies in which the company has a business presence, most risk and exposure for unclaimed property usually lies with the company’s state of legal domicile. Risk and exposure increases if there is a lax history of compliance or there are limited available historical financial records. Liability is typically estimated in such circumstances, and the state of legal domicile is generally entitled to claim the entire estimated amount.

Interestingly, while the Supreme Court has addressed unclaimed property jurisdictional rules several times (Standard Oil Co. v. New Jersey, 341 U.S. 428 (1951); Texas v. New Jersey; Pennsylvania v. New York, 407 U.S. 206 (1972); Delaware v. New York, 507 U.S. 490 (1993)), there have been no federal cases that address the use—or permissibility—of estimates. And the authors are aware of only one state case that has considered the use of estimates in the context of an unclaimed property audit (New Jersey v. Chubb Corp., 570 A.2d 1313 (N.J. Super. Ct. Ch. Div. 1989)). It is worth noting that in Chubb, the New Jersey court concluded that the jurisdictional guidelines established by the Supreme Court in Texas v. New Jersey were relevant only to conflicts among states, and the rules did not apply to disputes between the state and a holder.

Relevance to Tax Practitioners

The relevance of unclaimed property to tax practitioners should now be obvious. Despite the differences, as administered and enforced by a number of states, unclaimed property looks and acts very much like a tax. Unclaimed property compliance is also often an organizational hot potato. It is technically not a tax, and it does not fall squarely into any single corporate function—there are legal aspects of rights to unclaimed property, accounting records to be tracked and analyzed, and annual reports to be filed with states. As a result, frequently no department within an organization claims ownership. If a company has not specifically assigned unclaimed property responsibilities to a functional group, chances are that no formal unclaimed property policies and procedures or reporting processes exist. This leads to heightened risk of audit and potentially significant unfavorable financial implications. Unfortunately, when the audit notice comes, it will usually find its way to the tax practitioner, who will be charged with “fixing the problem.”

What should tax practitioners do? At a minimum, they should educate their company’s CEO, CFO, or general counsel. While they can be reminded that unclaimed property is not a tax, executives should be made aware of the potential risks and financial exposure. Taking further steps, practitioners can determine if there is a history of compliance and if someone in the organization already has responsibility for tracking and reporting unclaimed property. Evaluating the company’s current policies and procedures and its compliance processes will provide a starting point for addressing possible gaps. Next, estimate potential unreported liability. Factors to consider include the company’s history of compliance, the availability and location of owner and historical financial records, states in which the company conducts business, and most important, the unclaimed property laws of the company’s state of legal domicile. If the amount of estimated exposure is significant, the company should consider entering into a voluntary disclosure agreement with one or more states. Most states have formal or informal voluntary disclosure programs under which penalties and interest are usually waived and lookback periods are shortened. Finally, once historical exposure has been addressed, companies need to adopt policies, procedures, and processes for prospective compliance.

Discharge of Indebtedness on Principal Residences and Business Real Property

2011-09-06T13:37:00.001-05:00

by John C. Zimmerman, CPA, MST, J.D.

EXECUTIVE SUMMARY

* Discharge of indebtedness income generally must be included in income. However, under Sec. 108(a)(1)(E), qualified principal residence indebtedness that is discharged is excluded from income.

* Qualified principal residence indebtedness is acquisition indebtedness up to $2 million. Principal residence for these purposes has the same meaning as it does for the Sec. 121 exclusion for gain on the sale of a principal residence.

* The tax consequences of a discharge of qualified principal residence indebtedness depends on whether the debt is recourse or nonrecourse.

* Under Sec. 108(a)(1)(D), a taxpayer other than a C corporation may exclude a discharge of qualified real property business indebtedness from income. For purposes of this exclusion, courts have held that the rental of a single property may qualify as a trade or business if the taxpayer is actively involved in the rental of the property.

The meltdown in real estate values in recent years has led to numerous debtor defaults and to creditors’ lowering the carrying values of mortgages. This article discusses the differing tax consequences under Sec. 108(a)(1)(E) of a borrower’s default and/or indebtedness discharge on recourse versus nonrecourse loans on principal residences. It then addresses the unresolved issue of what constitutes business indebtedness for purposes of the Sec. 108(a)(1)(D) exclusion from taxation for discharge of qualified real property business indebtedness. Planning opportunities are presented in each section.

Principal Residence Indebtedness

Sec. 61(a)(12) provides that gross income includes income from the discharge of indebtedness. However, as introduced by the Mortgage Forgiveness Debt Relief Act of 20071 and extended by the Emergency Economic Stabilization Act of 2008,2 Sec. 108(a)(1)(E) excludes from gross income qualified principal residence indebtedness discharged after 2006 and before January 1, 2013. Sec. 108(h)(2) states that qualified principal residence indebtedness is “acquisition indebtedness” as defined in Sec. 163(h)(3)(B), except that the total indebtedness excluded for purposes of Sec. 108 is $2 million, not the $1 million mentioned in Sec. 163(h)(3)
(B)(ii).

Sec. 163(h)(3)(B)(i) defines acquisition indebtedness as indebtedness that is incurred in acquiring, constructing, or substantially improving any qualified residence and is secured by the residence. The term also includes refinancing indebtedness as long as the refinanced loan does not exceed the original indebtedness. However, if the refinanced indebtedness in excess of the original acquisition indebtedness is used to substantially improve the principal residence, it will also be considered acquisition indebtedness. The above definition of acquisition indebtedness excludes home equity indebtedness unless the taxpayer uses the equity debt to make improvements to the principal residence. Hence, absent finding some other provision that would exclude discharged home equity indebtedness from income (i.e., title 11 bankruptcy under Sec. 108(a)(1)(A)) or insolvency under Sec. 108(a)(1)(B), such discharge will result in income recognition.

Sec. 108(h)(5) defines a principal residence as having the same meaning as used in Sec. 121. Sec. 121(a) provides that for a residence to qualify as a principal residence, the taxpayer must own and use the residence for two of the five years preceding the sale by the taxpayer. The ownership and use tests need not be concurrent. The exclusion is limited to $250,000 in the case of an individual and $500,000 in the case of a married couple filing jointly. Sec. 121(a)(2)(A) provides that for a married couple, both spouses must meet the use requirement but only one spouse must meet the ownership requirement.

When a creditor reduces a loan balance on the principal residence, Sec. 108(h)(1) provides that the basis of the residence shall be reduced (but not below zero) by the amount of the discharge. However, Sec. 108(h)(3) states that the general rule of nontaxability will not apply if the reason for the discharge is services performed by the debtor for the lender or any other factor not related to the decline of the property’s value or the taxpayer’s financial condition.

Further, under Sec. 108(a)(2)(A) the general exclusion rule on principal residence indebtedness discharge will not apply if the discharge occurs in a title 11 bankruptcy case. Rather, the exclusion under Sec. 108(a)(1)(A) will apply. However, Sec. 108(a)(2)(C) provides that the principal residence exclusion rule will take precedence over the insolvency exclusion rule listed in Sec. 108(a)(1)(B) unless the taxpayer elects otherwise. A taxpayer who uses any of the income exclusion provisions under Sec. 108 must file with the tax return Form 982, Reduction of Tax Attributes due to Discharge of Indebtedness (and Section 1082 Basis Adjustment).

As noted above, the total amount of principal residence indebtedness that qualifies for relief is $2 million. However, there will be no limit on the amount of relief if the debt is a purchase money mortgage as described in Sec. 108(e)(5). This means that the property’s seller is carrying the mortgage. This is not an unusual occurrence for very large mortgages where a third party may not be willing to extend credit. Debtors who have purchase money mortgages simply reduce their basis in the property by the amount of the indebtedness discharge. It should be emphasized that the provisions of Sec. 108(e)(5) apply to all property, not only principal residences. However, the exclusion will not apply in a title 11 case or when the purchaser is insolvent.

Recourse and Nonrecourse Debt

The tax consequences of principal residence acquisition indebtedness discharge can have differing impacts depending upon whether the debt is recourse or nonrecourse. Recourse debt means that the debtor can be held personally liable in the event of default. Thus, if the fair market value (FMV) of the property that secures a loan is not sufficient to cover the outstanding principal of the loan in the event of default, a creditor can attach other property owned by the debtor to cover the loan balance. Nonrecourse debt means that the creditor can seize only the property that secures the loan, even if the FMV of that property is not sufficient to cover the loan balance. For example, principal residences are sold in California on a nonrecourse basis. Hence, homeowners can walk away from their loans without fear of being pursued by the creditors.

The regulations provide that relief of a nonrecourse loan will be sufficient consideration received for property that is in default.3

Example 1: Taxpayer T defaults on a nonrecourse mortgage loan of $300,000. The principal residence basis is $320,000, and the FMV is $250,000. The property is considered to be sold for $300,000, and its FMV is irrelevant for purposes of determining liability relief.4 T has an unrecognized $20,000 loss because the property is personal use property. However, there are no further tax consequences as a result of the default.

The taxpayer can simply walk away from the loan. The lender issues the taxpayer Form 1099-A, Acquisition or Abandonment of Secured Property. The taxpayer does not file a Form 982 because there has been no discharge of indebtedness. The taxpayer reports the sale on a Form 1040, Schedule D, Capital Gains and Losses. Since a loss cannot be recognized, the sale price (i.e., the balance of the nonrecourse loan) and property’s basis will be the same: $300,000.

However, if the nonrecourse lender cancels part of the debt for $600 or more under the repossession (e.g., a lender cancels part of the debt and then later in the year forecloses), the lender must file Form 1099-C, Cancellation of Debt. In that case, it can report the repossession information in boxes 4, 5, and 7 of Form 1099-C instead of filing Form 1099-A.5 The taxpayer files Form 982 and Schedule D.

In the above example, if the lender has recourse against the taxpayer for property other than the property securing the loan, the treatment changes.6 The borrower automatically has discharge of indebtedness income of $50,000, the difference between the property’s FMV ($250,000) and the loan balance on the property ($300,000). The property is then considered sold for the remaining $250,000 debt securing the property. This results in a $70,000 loss that the taxpayer cannot recognize for tax purposes because the principal residence is personal use property. However, the taxpayer is allowed to treat the indebtedness discharge under the general rule of Sec. 108(a)(1)(E). The taxpayer files Form 982 showing the amount of the discharge excluded from income and also files Form 1040, Schedule D, showing a sale for $250,000 and a basis of $250,000.

Many recourse lenders are allowing taxpayers to sell their principal residences in what is referred to as a short sale.

Example 2: Taxpayer V sells her principal residence property for less than the mortgage that secures it. The lender issues Form 1099-C to V. Box 5 on the form asks whether the taxpayer is personally liable (recourse liability). If V is personally liable, she either must recognize income from the discharge of indebtedness or is allowed the exclusion from the discharge if the requirements of Sec. 108(a)(1)(E) are met.

In the above illustrations there are effectively no differences for tax purposes between the nonrecourse and recourse notes securing the property. The only difference, as noted, is how the transactions are reported when the taxpayer loses the principal residence. This situation changes if the loan balance discharged exceeds $2 million, because that is the maximum amount eligible for relief.

Example 3: Taxpayer W has a basis in her principal residence of $9 million, an FMV of $5 million, and a loan balance of $8 million. W defaults, and the property is repossessed by the lender. There are no tax consequences if this is a nonrecourse mortgage; it is simply treated as a sale of the property for $8 million. However, if the note is recourse and the lender allows W to enter into a short sale, she will have $3 million of discharge of indebtedness income, the difference between the mortgage on the property and its FMV. W has $1 million of income recognition, since she can exclude only $2 million under the general rule. The remaining $5 million is treated as consideration paid for the property. The basis of the property is reduced by the $2 million, leaving W with an unrecognized loss of $2 million ($5 million remaining loan less $7 million remaining basis).

Complications also arise if the taxpayer has borrowed against the increased value of the property during times when real estate values were high. Equity borrowing was quite common before the real estate meltdown. The relief afforded under Sec. 108(a)(1)(E) does not apply to equity borrowing.

Example 4: Taxpayer X has a nonrecourse acquisition note and a nonrecourse equity note on his property. The equity loan proceeds are not used for improvements to the principal residence. X’s basis is $500,000 (original acquisition cost), FMV is $350,000, principal acquisition residence indebtedness is $450,000, and equity debt is $150,000. Third-party holders of the debts cancel $50,000 of the acquisition indebtedness and $100,000 of the equity debt. X keeps the home and recognizes $100,000 discharge of indebtedness income on the equity debt.

Each debt discharge will be reported to X on a Form 1099-C. However, X can exclude the $50,000 of acquisition indebtedness under the general rule. In this example, the results are the same if the debt is recourse because X has not disposed of the principal residence.

However, the results change if the taxpayer gives up the principal residence either through foreclosure (nonrecourse mortgage) or a short sale (recourse mortgage). If both loans are nonrecourse and the creditors foreclose, he will have $100,000 of capital gain ($600,000 of debt relief on a principal residence with a basis of $500,000). If he meets the criteria of Sec. 121 for exclusion of gain on the sale of a principal residence, he will not have to recognize any of the gain. Even if he must recognize the gain, the taxpayer has the advantage of the long-term capital gain rates instead of the ordinary income rates on $100,000 that he would have to recognize as discharge of indebtedness income if he keeps the principal residence.

If the debts are recourse, the taxpayer will not have the benefit of capital gain recognition and Sec. 121 exclusion. If the creditors allow him to engage in a short sale for $350,000, the home’s FMV, he will have $150,000 of ordinary income on the equity debt discharge and $100,000 ordinary income on the acquisition debt discharge. He will be allowed the benefit of the Sec. 108(a)(1)(E) exclusion only on the $100,000 of acquisition debt. Thus, if the debts are nonrecourse, the taxpayer has $100,000 of capital gain potentially eligible for the Sec. 121 exclusion. If they are recourse, there is $250,000 of ordinary income of which the taxpayer can exclude only $100,000 from recognition.

Planning Opportunities

As the above examples illustrate, there are far more planning opportunities with nonrecourse as opposed to recourse mortgages. In some instances with a nonrecourse mortgage, the tax consequences of default can be more favorable than the consequences of keeping the home. This will be the case if there is a nonrecourse equity loan that will not qualify for the Sec. 108(a)(1)(E) exclusion.

Example 5: Taxpayer Y purchases a house for $550,000. At present, there is no acquisition indebtedness. Y borrows $500,000 on the house’s equity when it is worth $650,000. The house’s present value is $400,000. If the nonrecourse equity lender agrees to discharge $100,000 of the loan so that Y will owe only the house’s FMV, there will be $100,000 of discharge of indebtedness income. However, there are no tax consequences if Y defaults and the house is repossessed. Y is considered to have sold the house with a tax basis of $550,000 for the amount of the $500,000 debt relief. If the debt is recourse and there is a short sale for $400,000, there will be $100,000 of ordinary income and a $150,000 loss that cannot be recognized for tax purposes ($550,000 of tax basis less the remaining $400,000 debt relief on the sale).

There can be no Sec. 108(a)(1)(E) relief since there is no principal residence acquisition indebtedness remaining on the loan. Hence, with nonrecourse mortgages it may be advantageous for tax purposes to simply walk away from the house and allow the lender(s) to repossess it.

Qualified Real Property Business Indebtedness

General Provisions

Sec. 108(a)(1)(D) excludes from income recognition for a taxpayer, other than a C corporation, a discharge of qualified real property business indebtedness. Sec. 108(a)(2)(A) provides that the exclusion is not available if the discharge occurs in a title 11 bankruptcy case. Sec. 108(a)(2)(B) provides that the exclusion will not apply to the extent that the taxpayer is insolvent. In that case, the insolvency provisions of Sec. 108(a)(1)(B) will apply. Secs. 108(c)(1) and (2) explain the rules for the maximum amount eligible for the exclusion and the basis reductions to depreciable real property when the exclusion is used. Essentially, the maximum exclusion allowed is the amount by which the qualified acquisition indebtedness (discussed below) exceeds the property’s FMV. However, the exclusion cannot exceed the property’s adjusted basis.

Sec. 108(c)(3) defines qualified real property business indebtedness as indebtedness:

* That is incurred or assumed by the taxpayer in connection with real property used in a trade or business that is secured by the real property;

* That is incurred or assumed before January 1, 1993, or if incurred or assumed after this date is qualified acquisition indebtedness (this includes refinanced indebtedness only to the extent it does not exceed the debt being refinanced); and

* With respect to which the taxpayer elects to have the exclusion applied.

The term does not apply to qualified farm indebtedness (covered under Sec. 108(a)(1)(C)).

Sec. 108(c)(4) provides that qualified acquisition indebtedness means indebtedness incurred to acquire, construct, reconstruct, or substantially improve real property used in a trade or business. Therefore, equity debt used for purposes other than capital improvements to the property on which the borrowing is made will not qualify. The taxpayer must make the election to use the provisions on a timely filed return (including extensions) for the tax year in which the discharge occurs. The taxpayer makes the election on a Form 982.7

In the case of a partnership, the determination of whether the debt is qualified real property business indebtedness is made at the partnership level. However, the election to apply the provision is made at the partner level.8 Hence, different partners may treat the discharge differently.

One of the problems with Sec. 108(a)(1)(D) is the lack of definition of what constitutes a trade or business for the section’s purposes. For example, if a taxpayer owns a rental property on which debt is discharged due to a decline in market value, can the rental be considered a trade or business for purposes of the section? Unfortunately, there is no definitive answer. Nevertheless, looking to Sec. 469, which deals with passive losses, can give some idea of how trade or business should be interpreted in light of Sec. 108(a)(1)(D). There is precedent for looking at another Code section when attempting to ascertain the meaning of a term. For example, the Third Circuit looked to the Sec. 108 meaning of indebtedness when trying to define the term “indebtedness” for purposes of Sec. 61(a)(12).9 In another case, the Supreme Court looked to obsolete cases to define “differing materially” as used in Regs. Sec. 1.1001-1. The cases had been decided long before the regulation’s enactment.10

Passive Loss Guidance

Sec. 469 deals with the rules for the passive loss limitations. Sec. 469(c)(7) provides “special rules for taxpayers in real property business.” Sec. 469(c)(7)(B) states that a taxpayer in a real property business is one who (1) spends more than one-half his or her personal service time performed in all trades or businesses in real property trades or businesses in which he or she materially participates and (2) performs more than 750 hours of services during the tax year in real property trades or business in which he or she materially participates. The problem is that many taxpayers will not be able to meet these requirements. In addition, if a taxpayer owns multiple real estate rentals, Sec. 469(c)(7)(A) applies the above rules to each rental separately, effectively meaning that it could be impossible to meet the test.

The taxpayer can elect to treat all interests in rental real estate as one property for purposes of the two tests. Taxpayers will generally make this election when they want to avoid the limitations for deducting passive losses. However, because of the operation of the passive loss rules, making such an election would mean that all properties covered under the election would have to be disposed of before any suspended passive losses could be deducted. Secs. 469(d) and (g) provide that a taxpayer can deduct suspended passive losses only when the taxpayer has sufficient passive income to offset such losses, disposes of his or her complete interest in the property that has generated suspended passive losses, or dies.

However, under Sec. 469(c)(6), to the extent provided in the regulations, “trade or business” means:

* Any activity in connection with a trade or business; or
* Any activity for which expenses are allowable under Sec. 212.

Sec. 212 allows expenses for activities conducted for the production of income. This could include expenses for real estate rentals in certain circumstances.11 Regs. Sec. 1.469-9(b)(1) states that “[a] trade or business is any trade or business determined by treating the types of activities in §1.469-4(b)(1) as if they involved the conduct of a trade or business, and any interest in rental real estate, including any interest in rental real estate that gives rise to deductions under section 212” (emphasis added).

Case Guidance

Court cases and IRS rulings have been ambiguous as to whether renting property constitutes a trade or business. Cases dating back to the 1940s have held that renting even a single property may constitute a trade or business. In Hazard,12 the taxpayer sold for a loss a single rental property that he had converted from a principal residence. The IRS argued that the loss was capital. However, the Tax Court looked to the then equivalent of current Sec. 1231(b), which defines “property used in the trade or business” as property “of a character which is subject to the allowance for depreciation.” On this basis, the court held that the loss was ordinary, and the IRS acquiesced. Courts also have decided subsequent cases in favor of taxpayers who sought to have losses on improved real estate rental properties treated as being from a trade or business.13 Where rental property used for sharecropping was unimproved, a district court held that the rental activity did not constitute a trade or business.14 Similarly, the Tax Court disallowed unimproved rental realty from being classified as a trade or business.15

In Grier,16 a district court case affirmed by the Second Circuit, a taxpayer’s ownership of property rented for 14 years was held not to constitute a trade or business. However, in that case it was the taxpayer who said that the rental did not constitute a trade or business, while the IRS argued that it did. The court looked to the taxpayer’s minimal efforts in managing the property and noted that there was a lack of “regular and continuous activity of management.” The Tax Court cited Grier in a case where a taxpayer held inherited rental property for only three months before its sale.17 In denying a classification of the property as being held in a trade or business, the court noted that the taxpayer’s “activities with respect to the premises as rental property were almost non-existent” and that no evidence was presented that she attempted to remedy any of the problems with the property.

The IRS indicated in Letter Ruling 835000818 that it would look to a taxpayer’s efforts in managing a rental property to determine whether the rental activity constituted a trade or business. The taxpayer leased property that required the lessee to be responsible for all tax assessments, maintenance, and repairs, and “all claims and liabilities arising out of or in connection with” the rental property. Such rental agreements are known as net leases. Based on these facts, the ruling held that the rental did not constitute a trade or business because “[t]he Taxpayer-lessor engaged in little or no activity with respect to the property.”

The IRS addressed the applicability of Sec. 108(a)(1)(D) to real estate rentals in Letter Ruling 9840026.19 The taxpayer, a partnership, rented residential apartments. The partnership was actively involved in managing the rental property. This included setting the rents, arranging for necessary repairs, hiring maintenance personnel, purchasing supplies, keeping books, and collecting rents. The IRS held that the taxpayer was in a trade or business. Significantly, the IRS stated that “[t]he rental of even a single property may constitute a trade or business under various provisions of the Code.” The ruling emphasized that net leases will not qualify as a trade or business, and cited an earlier case20 and revenue ruling21 to this effect.

The substance of the cases and rulings on whether a real estate rental will constitute a trade or business is that the taxpayer must be actively involved in the rental. There is no guidance on what exactly constitutes such involvement. However, the IRS’s interpretation of Sec. 469(i), which provides a limited exception to the passive loss rules for certain rental real estate for an individual who actively participates in the rental, may provide some guidance. The IRS has defined such active participation as making “management decisions in a significant and bona fide sense.”22 This includes “approving new tenants, deciding on rental terms, approving expenditures, and similar decisions.”

Passive Loss Definition vs. Case Definition

Recall that the passive loss definition for a rental real estate business envisages property held for the production of income as defined in Sec. 212. The cases and rulings discussed above, though not saying so directly, mean a trade or business as defined in Sec. 162, concerning “ordinary and necessary” deductions for a trade or business. In Curphey,23 the taxpayer, who was a medical doctor, took a home office deduction under Sec. 280A for managing his six rental properties. Sec. 280A(c)(1)(A) allows the deduction when the home office is the taxpayer’s “principal place of business.” His efforts included “personal efforts to manage the six units in seeking new tenants, in supplying furnishings, and in cleaning and otherwise preparing the units for new tenants. These activities were sufficiently systematic and continuous to place him in the business of real estate rental.”24

However, the court emphasized that it was allowing the expense deductions under Sec. 162, not Sec. 212. The court stated that it disallowed the deduction under Sec. 212 because that section concerned expenses for the production of income. The court did not believe that such expenditures would rise to the level of a trade or business. It stated that there is no deduction under Sec. 280A for “use of a home in connection with an activity which is merely for the production of income within the meaning of section 212 but is not a ‘trade or business’ under section 162.”25 A production of income example could be where a taxpayer used his or her principal residence to manage a stock portfolio.

Curphey and the other aforementioned cases were decided before the enactment of the passive loss rules’ definition of a trade or business as coming within the scope of Sec. 212. Hence, the courts have not decided whether Sec. 469 could create a lower threshold for purposes of a trade or business. Most likely the approach taken in Letter Ruling 9840026 and the cases it cites, discussed above, will continue to govern the definition of a trade or business for purposes of defining qualified real property business indebtedness. Moreover, it could even be argued that the test is the same whether for purposes of Sec. 162 or Sec. 212. The regulations under Sec. 212 state that “ordinary and necessary expenses paid or incurred in connection with the management, conservation, or maintenance of property held by the taxpayer as rental property are deductible.”26 Hence, there are situations when the same level of effort could be required under both sections for real estate rentals.
Differences Between Discharges for a Principal Residence and Property Used in Business

The issues surrounding qualified real property business indebtedness from the perspective of recourse and nonrecourse liabilities will be the same in some instances as those for a principal residence. Thus, a nonrecourse holder of such property will be able to default and have the reacquisition of the property by the lender treated as a sale or exchange. This result does not change when part or all of the debt on the property is equity debt. It simply will be treated as consideration for the sale of the property. However, in this instance, unlike with a principal residence, the taxpayer can recognize a Sec. 1231 ordinary loss in certain circumstances.

Example 6: Taxpayer Y borrows $400,000 on real estate rental property with a basis of $500,000. The property’s value drops to $350,000. There is no other debt on the property. Y defaults and the property is repossessed. Y recognizes a $100,000 ordinary loss. The property is treated as if it has been sold for $400,000. Y cannot recognize a loss if the property is a principal residence.

The same result occurs if the loan in the above example is recourse and the lender allows the taxpayer to engage in a short sale. In this instance, the taxpayer will have ordinary discharge of indebtedness income of $50,000, the difference between the equity debt ($400,000) and the property’s FMV ($350,000). However, the taxpayer would then recognize an ordinary loss under Sec. 1231 for $150,000, the difference between the basis ($500,000) and the remaining debt ($350,000). Thus, the taxpayer has effectively neutralized the discharge of indebtedness income. If the property was a principal residence, the taxpayer would recognize $50,000 of ordinary income but could not recognize any loss on the sale because it is personal use property.
Conclusion

The exceptions to income recognition for discharge of indebtedness income for a principal residence can have differing tax impacts depending upon whether the debt is nonrecourse or recourse. Obviously, there are situations in which a taxpayer will be in a more advantageous position when the debt is nonrecourse, because the property’s FMV fluctuations will not affect the tax considerations in the event of a default. The total debt, both acquisition and equity, will be treated as consideration for the sale. However, the taxpayer will have discharge of indebtedness income on equity debt relief when the loan is recourse and the lender allows a short sale. In this instance, any loss on the sale cannot be used to offset the income because the principal residence is personal use property.

When the taxpayer keeps the principal residence, the discharge will have the same impact for nonrecourse and recourse debt. In both instances, the taxpayer can reduce the basis of the principal residence by up to $2 million of the discharge for acquisition indebtedness. In both instances, the taxpayer will also have to recognize income from any discharge of equity debt.

Taxpayers may exclude from gross income qualified real property business indebtedness, not to exceed the amount by which such indebtedness exceeds the property’s FMV. The amount is further limited to the property’s adjusted basis. Real estate rental properties can qualify as a trade or business for this purpose. A single real estate rental also may qualify as a trade or business. The only issue is how much effort a taxpayer must put into the rental properties to have the activity classified as a trade or business. Though there is no fixed rule, the substance of the cases and rulings (especially Letter Ruling 9840026) suggest that the taxpayer must be actively involved in the management decisions for the property, including setting rents, approving repairs and other expenditures, and approving tenants. It is clear that debt on a property subject to a net lease, where the lessee is responsible for the property’s management and expenditures, will not qualify for the exclusion. In this case, the lessor-owner will not have performed sufficient functions to be considered to be in a trade or business for purposes of Sec. 108(a)(1)(D).

This article should help practitioners decide when to advise clients to engage in partial debt discharge, short sales, and/or outright defaults on principal residence indebtedness and qualified real property business indebtedness. Of particular concern will be whether the property is secured by a recourse or nonrecourse note and whether the debt is acquisition or equity indebtedness. In each instance the tax consequences can vary dramatically depending upon the nature of the debt and the action to be taken.

Footnotes

1 Mortgage Forgiveness Debt Relief Act of 2007, P.L. 110-142.

2 Emergency Economic Stabilization Act of 2008, P.L. 110-343.

3 Regs. Secs. 1.1001-2(a)(1) and (a)(4)(i).

4 Regs. Sec. 1.1001-2(b).

5 Instructions for Forms 1099-A and 1099-C (2011), p. 1. See also IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions and Abandonments (2010), p. 12.

6 Regs. Sec. 1.1001-2(a)(2), and see Regs. Sec.1.1001-2(c), Example (8).

7 Regs. Sec. 1.108-5(b).

8 IRS Letter Ruling 9840026 (10/2/98), citing the legislative history; Sec. 108(d)(6). See also Gershkowitz, 88 T.C. 984 (1987).

9 Zarin, 916 F.2d 110 (3d Cir. 1990).

10 Cottage Savings Ass’n, 499 U.S. 554 (1991).

11 See Bolaris, 776 F.2d 1428 (9th Cir. 1985), where real estate rental deductions, including depreciation under Sec. 167, were allowed under Sec. 212. The taxpayer was allowed to show a loss for tax purposes on a temporary rental of a principal residence.

12 Hazard, 7 T.C. 372 (1946), acq., 1946-2 C.B. 3.

13 Stratton, T.C. Memo. 1958-214; Post, 26 T.C. 1055 (1956), acq., 1958-2 C.B. 7; Schwarcz, 24 T.C. 733 (1955), acq., 1956-1 C.B. 5; Gilford, 201 F.2d 735 (2d Cir. 1953).

14 Durbin v. Birmingham, 92 F. Supp. 938 (S.D. Iowa 1950).

15 Emery, 17 T.C. 308 (1951).

16 Grier, 120 F. Supp. 395 (D. Conn. 1954), aff’d without discussion, 218 F.2d 603 (2d Cir. 1955).

17 Balsamo, T.C. Memo. 1987-477.

18 IRS Letter Ruling 8350008 (12/16/83).

19 IRS Letter Ruling 9840026 (10/2/98).

20 Neill, 46 B.T.A. 197 (1942).

21 Rev. Rul. 73-522, 1973-2 C.B. 226.

22 IRS Publication 925, Passive Activity and At-Risk Rules (2010), p. 3.

23 Curphey, 73 T.C. 766 (1980).

24 Id. at 775.

25 Id. at 770.

26 Regs. Sec. 1.212-1(h).

Real Estate Transfer Taxes: Practical Considerations

2011-09-06T13:28:00.000-05:00

By Alistair M. Nevius

Approximately two-thirds of U.S. states, as well as a number of municipalities, counties and other units of local government, impose a tax on taxpayers when they transfer real property to another party. As a practical matter, a real property transfer tax is typically triggered if a deed is recorded; however, taxpayers often transfer real estate to a new owner without recording a deed, for example, by transferring the ownership interest in an entity that holds title to the property. Given such a loophole, it is small wonder that taxpayers have created entities and engineered transactions in order to avoid this tax.

Beginning with New York in 1986, a number of jurisdictions that impose a real estate transfer tax now require taxpayers who engage in these types of transfers to pay the tax. The imposition of tax occurs when the transfer is deemed to be an indirect transfer of ownership in real property, even if a deed is not recorded. Jurisdictions that have adopted this approach treat transfers of a controlling interest in a legal entity, such as a corporation, as taxable transfers of real property.

A taxpayer is often deemed to have transferred a controlling interest if more than 50% of the ownership interest in the legal entity is transferred to a new owner. The list of legal entities is usually inclusive and includes trusts and single-member limited liability companies. Because there is no reference to federal income tax concepts in these statutes, practitioners who are used to treating entities as disregarded for federal income tax purposes are required to regard them for purposes of applying these concepts.

TWO APPROACHES TO THE CONTROLLING INTEREST CONCEPT

In most cases, the states that have adopted a controlling interest concept take one of two approaches for determining whether a transfer of a controlling interest represents a taxable conveyance of real property:

States that take a broad approach generally tax transfers of a controlling interest in an entity that owns in-state property. Jurisdictions that adopt this approach can and do impose tax in connection with business acquisitions, mergers, stock sales or other changes in a legal entity’s ownership. This type of approach can be a surprise for taxpayers who are more familiar with the traditional transfer tax concepts. States that take a more narrow approach tax a transfer of a controlling interest only in situations where the entity being transferred is primarily in the business of owning real estate. Whether an entity is primarily in the business of owning real estate is determined by measuring the entity’s real estate activity against its total activity, and these states differ significantly in how they determine whether a particular company is subject to the tax.

For a detailed discussion of the issues in this area, see “Controlling Interest Provisions in State and Local Real Estate Transfer Taxes,” by Donald R. Dennis, CPA, and Jonathan M. Cesaretti, J.D., in the September 2011 issue of The Tax Adviser.

Three Tips for Employers Outsourcing Their Payroll

2011-09-02T14:25:00.000-05:00

Outsourcing payroll duties to third-party service providers can streamline business operations, but the IRS reminds employers that they are ultimately responsible for paying federal tax liabilities.

Recent prosecutions of individuals and companies who - acting under the guise of a payroll service provider - have stolen funds intended for payment of employment taxes makes it important that employers who outsource payroll are aware of the following three tips from the IRS:

1. Employer Responsibility The employer is ultimately responsible for the deposit and payment of federal tax liabilities. Even though you forward the tax payments to the third party to make the tax deposits, you - the employer - are the responsible party.

If the third party fails to make the federal tax payments, the IRS may assess penalties and interest. The employer is liable for all taxes, penalties and interest due. The IRS can also hold you personally liable for certain unpaid federal taxes.

2. Correspondence If there are any issues with an account, the IRS will send correspondence to the address of record. The IRS strongly suggests you do not change the address of record to that of the payroll service provider. That could limit your ability to stay informed of tax matters involving your business.

3. EFTPS Choose a payroll service provider that uses the Electronic Federal Tax Payment System. You can register on the EFTPS system to get your own PIN to verify the payments.

The IRS web site – www.irs.gov has more information on the responsibilities of employers outsourcing payroll, payroll service providers and EFTPS.

Small Business Owners: IFRS Offers No Benefit for Us

2011-09-02T14:22:00.000-05:00

Is small business clamoring for a change from GAAP-based reporting standards to IFRS. Not to hear small business owners tell it. Speaking at a roundtable conference organized by the U.S. Securities and Exchange Commission, executives from several small public companies and their auditors said that a shift to international financial reporting standards would be of little—if any—benefit, would prove costly, and should not be done precipitously. One panelist summed up the views of those on the panel by saying, “we have nothing to say positively at all” about U.S. use of IFRS. “All it's going to do is cost us money.”

The smaller companies declared that very few of their investors are asking for a switch to IFRS or see any real advantage in it. Further, from the perspective of private companies, banks are the only entities routinely requiring audited financial statements but they are concerned almost solely with cash flow, regardless of the accounting rules used to report it, according to panelists.

The bottom line: show us where the benefit is before we spend time and money changing our financial practices.

PCAOB Seeks Comment on Audit Firm Rotation Requirement

2011-09-02T14:19:00.002-05:00

Public Company Accounting Oversight Board voted unanimously on August 16 to ask for public comment on a proposal to require public companies to change their auditing firms from time to time. The PCAOB is discussing this proposal due to concerns that auditing firms may lack independence or objectivity if they have been auditing the same company for many years.

Proponents of term limits say breaking up the close relationships will lead to improved objectivity on the part of auditors, while critics say they will lead to costly inefficiencies and even more mistakes as an auditing firm gets acquainted with a new client. PCAOB Chairman James R. Doty said at the board's August 16 open meeting in Washington, “I hope to challenge critics and proponents alike to do their homework, come forward with facts, and add meaningful depth to the discussion in order that we might reach a resolution.”

The concept release calls for public comment for 120 days to be followed by a public roundtable discussion on audit independence and mandatory audit firm rotation scheduled for March 2012.

While firm rotation was the solution that received the most attention at the PCAOB meeting, board members said they are willing to consider other methods of protecting investors by ensuring auditor independence and objectivity.

During the PCAOB discussion Doty noted that Congress considered mandatory audit firm rotation when it debated the Sarbanes-Oxley Act of 2002. Congress directed the Government Accountability Office to study the matter, and the GAO essentially concluded that the reforms that were included in the act should be given time to work and that rotation could, if necessary, be revisited again by the board and the SEC. Several PCAOB Board members commented that it makes sense to now follow up on GAO's suggestion.

The public comment period ends on December 14. Any requirements adopted by the PCAOB must be approved by the Securities and Exchange Commission.

Signed Tax Return Not Valid When Altered by Preparer

2011-09-02T14:17:00.002-05:00

A tax return that has been signed by a taxpayer but is altered by the return preparer, without the taxpayer's knowledge, before it is filed is not valid. This advice was contained in a project manager technical advice memorandum, PMTA 2011-20.

The memorandum noted that some preparers (who were subsequently indicted for fraud) have altered returns previously approved by taxpayers by overstating income, deductions, credits, or withholding. The inflated items create a larger-than-expected refund and the preparer keeps the excess over that reflected on the return signed by the taxpayer, it said.

According to the PMTA, an altered return fails to meet the tests for a valid tax return because the document submitted to the IRS is not the document signed and approved by the taxpayer or authorized to be filed electronically with the IRS, it said.

Final Regulations Issued to Establish Proof of Document Delivery

2011-09-02T14:15:00.000-05:00

Have you ever needed to ensure a document was delivered to the IRS on or before a specific date? How can you prove it? Final regulations address the matter.

The IRS has issued final regulations providing ways to establish evidence of delivery of documents that have filing deadlines prescribed by internal revenue laws when direct proof of actual delivery is absent. The regulations are effective August 23 and apply to any payment or document mailed or delivered in accordance with the regulations in an envelope with a postmark dated after Sept. 21, 2004 (not a misprint – 2004).

According to the regulations, proper use of registered or certified mail or a service of a private delivery service will constitute prima facie evidence of delivery of documents. The final regulations are in response to a notice of proposed rulemaking issued in 2004, thus the retroactive applicability.

According to the announcement, “These final regulations provide that, other than direct proof of actual delivery, proof of proper use of registered or certified mail (registered or certified mail sender's receipt), and proof of proper use of a PDS [private delivery service] duly designated under criteria established by the IRS, are the sole means to establish prima facie evidence of delivery of documents that have a filing deadline prescribed by the internal revenue laws.”

The announcement also stated that Section 7502 does not authorize the Treasury Department or IRS to adopt a rule that would permit priority mail or other services from the Postal Service beyond certified and registered mail to establish prima facie evidence. Legislation would be needed to make this authorization. Therefore, the IRS clarified that absent actual delivery first class mail without additional service provides nothing to establish proof of delivery.

CRS Report Details Individual Mandate and Potential Penalties

2011-09-02T14:09:00.000-05:00

The non-partisan Congressional Research Service on August 22 released a report detailing how the individual mandate included in the federal health care reform law will work if and when it takes effect in 2014. Because Congress decided that the IRS should have a role in enforcing the law, tax practitioners may well have a role as well, like it or not.

The Patient Protection and Affordable Care Act requires individuals to have insurance that meets minimum standards or else face financial penalties, with a few exceptions. CRS takes the view that the individual mandate is considered a very important part of the law because it ensures healthy people obtain coverage, which in turn helps spread risk and keep costs down. The constitutionality of the individual mandate has been challenged in lawsuits, and the courts have issued opposing rulings. The question ultimately is expected to reach the Supreme Court.

According to the report, PPACA does grant exemptions from the individual mandate penalty if, for example, coverage is deemed unaffordable. In addition, the law allows exemptions from the individual mandate for those with religious objections, in a health care sharing ministry, not legally present in the United States, or incarcerated, according to the report.

If a person subject to the individual mandate fails to obtain coverage and fails to pay the penalty, he or she will receive a notice from the IRS. If the penalty remains unpaid, the IRS can collect the money by reducing a future tax return, but cannot file notice of lien or file a levy on any property. Those who fail to pay the penalty also will not be subject to criminal prosecution or penalty, according to the report.

The law also sets forth reporting requirements to ensure IRS knows who has obtained proper coverage, as well as to make sure individuals know whether the coverage they obtain meets the requirements for adequate coverage, according to the report. The IRS has not yet detailed the reporting requirements or any proposed reporting forms. CRS also included examples of how much an individual or family would pay if they did not obtain adequate coverage.

OPR Outlines Activities Forbidden To Practitioners Under Suspension or Disbarment

2011-09-02T14:00:00.000-05:00

Circular 230, as amended and in effect as of August 2, provides that tax return preparation is “practice” before the IRS. Accordingly, when the IRS Office of Professional Responsibility suspends or disbars a practitioner from “practice” what does that mean?

For OPR, the answer is very clear: because of Circular 230 section 10.79, tax practitioners who have been suspended or disbarred are prohibited from activities such as communicating with the IRS on behalf of taxpayer rights, representing taxpayers at IRS conferences, hearings, and meetings, and preparing and filing taxpayer documents with the IRS. Please note that preparation is prohibited even if the document is filed with the IRS by some one else. Furthermore, attempting to practice before the IRS while disbarred or suspended could keep practitioners from being reinstated. The guidance also said the degree to which individuals comply with the terms of their sanctions will affect whether they are reinstated.

Another restriction prohibits suspended or disbarred practitioners from rendering written advice on transactions that have a potential to reduce taxes. The IRS may be facing a court challenge, some have suggested, because of constitutional questions about the extent to which the service can regulate, and therefore prohibit, practitioners from communicating in writing with their clients about taxes in the absence of any return or document intended to be filed with the Service.

Running Your Own Business

2011-09-02T10:33:00.000-05:00

Starting a business may be quite easy but the problem comes in when running the business to realize good returns. Some investors may run their own businesses while others will decide to be passive and hire professional to run and make business decisions for them. Whichever the case may be, one needs to be well equipped with knowledge and skills to run and monitor the progress of the business to keep the business alive and realize some profits.

Record keeping

Record keeping is the most crucial element of running a business. Without proper records, you have no way of knowing whether or not your business is profitable, and you have no idea what products or services are working (selling well) for your business. You also have no idea what your federal (and/or state) tax liabilities are (such as income tax liability, payroll liabilities, sales tax liabilities, etc.).

You need to be able to make wise decisions on what documents to keep indefinitely, which to discard after some time and the ones to discard immediately. Some examples are as follows:

* Records to keep indefinitely- list of assets, tax forms, property deeds, loan papers, financial assets’ list etc.

* Records to discard after some time- warranties, mortgage records, bank statements, cancelled checks, manuals for appliances, contract forms, insurance papers etc.

* Records to discard immediately- manuals for disposed appliances, receipts for small purchases etc.

Handling employees’ benefits

You should have a proper plan of the benefits you offer to your employees whether for safety, motivation or even satisfaction as these have a great impact on the business. Some of these benefits include health insurance, retirement plans, disability insurance, flexible compensation and leave among others.

Every business owner should come up with an employees’ benefit plan which should protect employees and their families in case of economic hardships. This ensures that you promote morale and retain your employees while other people will be eyeing for a chance to work in your business.

You can come up with some financial plans for your business which include:

* Making a succession plan for management and ownership of the business for example in case of incapacity or death. This ensures a smooth and orderly transition of the business.

* Opt for business forms like limited liability partnership or limited liability company

* Avoid nondeductible compensation

* Establish a retirement plan like setting up a Savings Incentive Match Plan for Employees where they can make contributions for use after retirement.

By keeping all the above in mind, you will successfully run your business with effective management plans and motivated employees.

Contact me at mastertype@mabspc.com with your questions. I will schedule a time when we can discuss your questions in detail.

Tax Planning For Small Business Owners

2011-09-02T10:26:00.000-05:00

Inadequate information on taxing system when starting a business can lead to significantly reduced profits and you may even end up closing the doors. Tax evasion is illegal and can be vital but looking for ways to reduce the amount you pay on taxes is not therefore one should have proper advice on this. If you don’t have experience in this, hire a trained tax planner to plan ways for your business to reduce its tax burden.

Types of tax systems for businesses

Corporate double tax – this is where the business and the owners are taxed separately. The business is taxed on the money it generates while the owners are taxed on the profits or dividends they get from the business. This system is used for a business corporation referred to as C corp. In this system, losses are not passed to the owners and are deducted only against profits.

Pass through taxation - in this system, the business is not taxed but the owners of the business are taxed on the income they earn from the business. In this method, losses are directly deductible by the business owners who use the system. This system is normally applied to:

* Partnerships with limited liabilities
* S corporations and
* Limited liability companies

It’s normally upon the business owner to make a wise decision on which tax system to adopt. It is advisable for new business owners who are likely to make losses at first to start with the pass through taxation so that they can deduct the losses against other income.

Understanding business entities

Partnerships- these do not have limited liability under the state law. However, they can be limited where the business is taken as a separate entity from its owners for example in corporations. In this case, the owners of the business remain passive in management of the business. Tax treatment is different for both general and limited partnerships.

S and C corps- S corp is an entity named from a chapter of the tax code and it’s a corporation with limited liability under state law. The owners of S corp adopt pass through taxation where they escape federal corporate tax after complying with some rules. C corps are taxed as corporations.

Limited liability companies (LLC) – these business entities have limited liability features and they adopt the pass through tax system. LLC members with limited liability can take active management of the business without affecting their liability.

Clearly understanding each business entity and tax systems is the first step towards having a good tax plan for your business.

Contact me at mastertype@mabspc.com for a free 1 hour consultation. I can help you to understand the tax consequences associated with any of the business entity types shown above, as well as sole proprietorships.

H&R Block posts wider 1Q loss, takes big charge

2011-09-02T10:16:00.000-05:00

By EILEEN AJ CONNELLY

NEW YORK (AP) — H&R Block Inc. on Thursday said that its fiscal first-quarter loss widened, largely because of a charge taken as part of its plans to sell its business consulting subsidiary.

The nation's largest tax preparer, which typically reports a loss in the first three months of its fiscal year, posted a net loss for the period ended July 31 of $175.1 million, or 57 cents per share. That compares with a loss of $130.7 million, or 41 cents per share, in the year-ago period.

The results included charges of 20 cents per share, mainly related to the sale, announced last month, of its RSM McGladrey unit. Excluding those charges, the adjusted loss was 37 cents per share.

Analysts, on average, expected a loss of 40 cents per share, according to data provided by FactSet.

Revenue fell 2 percent, to $267.6 million, from $274.5 million last year. That missed Wall Street expectations for revenue of $276.3 million.

Block, based in Kansas City, Mo., is gearing up for the 2012 tax season, which begins in January. "We had a lot of momentum that we came out of last season with, and we're looking to build on that," said Chief Financial Officer Jeff Brown in an interview.

Block announced in late August that it plans to sell RSM McGladrey back to McGladrey & Pullen LLP for about $610 million, 12 years after buying the consulting business. Since 1999, McGladrey & Pullen has operated under an alternative practice structure with RSM McGladrey. Under that arrangement, RSM McGladrey has provided nonpublic accounting services, including most tax and consulting services, while McGladrey & Pullen provided clients with public accounting services such as audits.

"We think it's the right strategy to exit the business now," Brown said. "It's good for Block, good for shareholders and good for the partners of McGladrey as well."

The deal, which still needs various approvals, is expected to close by the end of the year.

The conclusion of another deal for the company is a bigger question.

Brown said Block expects to appear Tuesday at a hearing related to the Justice Department's move to nix the company's acquisition of 2S Holdings Inc., the parent of the software company that created TaxAct. Block announced plans in October to buy TaxAct for $287.5 million, but the government is concerned about reduced competition in the market if the two companies combine.

"We continue to believe TaxAct would be a good strategic fit for the company," Brown said.

During a conference call to discuss the results, the issue of market share growth in the digital, do-it-yourself category was raised, with one analyst noting that rival Intuit Inc. recently claimed it gained market share during the 2011 tax season. Block has also made such claims.

"They did mention that they gained share," said CEO William Cobb. "We gained share. It's hard to speculate, since the only information we have is IRS data and the public filings of our competitors. And essentially I think we gained share, clients and share."

Oppennheimer analyst Scott Schneeberger asked what that means for TaxAct and other players. "I think it's implied that if both you and they took share. the smaller players including TaxACT probably lost a little."

Block executives declined to speculate if that is the case.

The company said its Sand Canyon Corp., the remnants of its former Option One Mortgage business, received claims of about $35 million during the quarter for alleged breaches of representation from investors trying to hold the company responsible for investment losses related to soured mortgages. It reviewed about $48 million in prior claims during the quarter and recorded losses of about $500,000. The small amount of losses means the reserves set aside to cover such claims remain essentially unchanged, Brown said.

The fear that Block might have to buy back bad mortgages made by Option One that were used to back investments has repeatedly come up, and some analysts say it has weighed on the stock. Block executives continue to maintain that the reserves set aside are adequate for any putbacks.

In light aftermarket trading, H&R Block shares slid 83 cents, or 5.5 percent, to $14.35, after closing up 6 cents at $15.18.

Regulator to sue major banks over mortgages

2011-09-02T10:14:00.000-05:00

By Margaret Chadbourn

WASHINGTON (Reuters) - A U.S. regulator is filing lawsuits against major banks, accusing them of bundling subprime home loans into bonds that never should have been sold to investors, and causing mortgage giants Fannie Mae and Freddie Mac to lose billions, a source said.

The Federal Housing Finance Agency, which oversees Fannie Mae and Freddie Mac, is suing major banks soon, in a move that will deepen the mortgage litigation morass for banks.

The biggest banks already face the potential for tens of billions of dollars of payouts to settle regulatory charges of abusive mortgage lending and foreclosure practices, and other investor lawsuits over mortgage debt losses.

These payouts would reduce earnings and weaken capital levels, perhaps harming the ability of banks to lend money and provide much-needed life to a stalled housing market and weakened economy.

Fannie Mae and Freddie Mac have also been stricken by bad mortgages, and are under government conservatorship after having previously been quasi-private. The two firms guarantee bonds backed by mortgages, and are a crucial pillar for U.S. housing finance system.

News of the lawsuits was first reported Thursday night on the website of The New York Times.

The source declined to name specific banks, but The New York Times reported that the banks to be sued include Bank of America Corp, JPMorgan Chase & Co and Goldman Sachs Group Inc among others. Representatives of Goldman, Bank of America and JPMorgan declined to comment.

(Reporting by Margaret Chadbourn, additional reporting by Jonathan Stempel; Editing by Dan Wilchins and Matthew Lewis)

Self-Employed Struggle as U.S. Recovery Offers Few Opportunities

2011-09-02T10:11:00.000-05:00

By Anna-Louise Jackson and Anthony Feld

Sept. 1 (Bloomberg) -- More than 1 million self-employed Americans are no longer in business almost four years after the last recession began, as the economy constrains entrepreneurial activity and small-business job creation.

The 18-month contraction that started in December 2007 initially resulted in more would-be business owners, as the number of people who work for themselves grew to 16.3 million in July 2008 from 15.7 million at the end of 2007, according to data from the Bureau of Labor Statistics. Since then, the total has fallen about 10 percent to 14.7 million in July, the data show.

Employer businesses -- those that provide work for individuals including the founder -- “have been starting in fewer numbers, with fewer workers and growing at a slower pace than in the past,” according to Robert Litan, a vice president at the Kansas City, Missouri-based Kauffman Foundation, which supports research on start-ups. “Therefore, these entrepreneurs are generating increasingly fewer new jobs for the U.S. labor market.”

The number of new employer businesses dropped 24 percent to 505,473 on an annual basis in 2010 from 667,341 in 2006, according to Litan, who co-wrote a report published in July on small-business job creation.

This has contributed to high unemployment as the economic recovery slows. The rate has remained above 9 percent for 25 of the past 27 months, falling to 9.1 percent in July from 9.2 percent in June, BLS statistics show. August data will be released September 2.

Obama’s Speech

President Barack Obama has said small companies can help spur expansion and will address a joint session of Congress on Sept. 8 to unveil plans to promote job growth. He told participants at a White House ceremony Aug. 29 that his proposals will include making it “easier” for entrepreneurs to hire people.

Small companies employ about half the private-sector labor force, so it’s “very difficult” for the jobless rate to improve when they’re “not doing well, because they are too big a part of the economy,” said Scott Shane, professor of entrepreneurial studies at Case Western Reserve University.

Their weakness is also “a very big problem” for office- supply retailers such as Staples Inc., Office Depot Inc. and OfficeMax Inc., which sell to small businesses, said Brad Thomas, an analyst with KeyBanc Capital Markets Inc. in New York. Same-store comparative sales for this industry have stagnated at an average zero percent in the past two years, while other retailers experienced some rebound following recessionary declines, he said.

Missing Links

“One of the missing links in this recovery has been stronger small-business growth, which is hurting the sales” of these companies, said Thomas, who is relatively cautious about the sector and maintains “hold” ratings on Staples and Office Depot.

During the economic slump, so-called “necessity entrepreneurs” started businesses because they couldn’t find a job and needed to keep food on the table, said Litan. While their work may be “laudable,” these mainly unincorporated sole proprietors are less likely to be major employers than firms that hire other workers in their first year, he said.

The number of unincorporated businesses -- some of them freelancers who require only a computer and Internet connection -- fell about 4 percent to 9.5 million in July from 9.9 million in December 2007, after reaching 10.6 million in July 2008, BLS data show. The number of incorporated self-employed dropped about 11 percent to 5.2 million in July from 5.8 million in December 2007.

Fewer Customers

A lack of customers and fewer opportunities forced many of these entrepreneurs out of business, according to Kristie Arslan, president and chief executive officer of the National Association for the Self-Employed, based in Washington. Small companies “are still in a recession because of a continued slowdown in the economy.”

This has limited their ability to spur an increase in jobs, because employer businesses started in 2009 generated between 700,000 and 1.2 million fewer positions compared with previous peaks in small-business job creation. About 56 percent of entrepreneurs who incorporate their businesses for tax and liability purposes had paid staff in 2005; 44 percent of them had between one and four workers, according to the most recent BLS survey.

Even as the decline in incorporated entrepreneurs appears to have moderated -- the number grew 0.7 percent in July from a year ago -- this group “has done little to return to where it was before the recession,” said Shane, a visiting scholar at the Federal Reserve Bank of Cleveland.

‘Crummy’ Economy

That’s because entrepreneurs aren’t immune to the “crummy” economy of the past four years that also hurt larger companies, according to Susan Woodward, president and founder of Sand Hill Econometrics in Palo Alto, California.

Small businesses grew during the housing boom because entrepreneurs are disproportionately exposed to the construction industry, as much as 10 times more than the U.S. economy overall, said Woodward, who also works with Intuit Inc. on its Small Business Employment Index. When the housing market collapsed, work for many carpenters and electricians vanished.

A higher exposure to retailing also hurt the self-employed, as consumer spending stagnated between July 2008 and November 2009, Shane said. Since peaking at an annual rate of 3.2 percent in November 2010, personal consumption expenditures adjusted for inflation slowed to 2.3 percent in July, according to the Bureau of Economic Analysis.

The extension of unemployment benefits -- to as long as 99 weeks in several states -- has influenced some people’s decisions about starting their own business, according to Kristie Arslan, president and chief executive officer of the National Association for the Self-Employed, based in Washington.

‘Calculated Assessment’

They “are trying to make a calculated assessment,” she said. Is the amount they’ll collect “going to be greater than what they’d make working for themselves?” And if they fail, they may no longer be eligible for these benefits, she added.

While incorporated entrepreneurs might pay into the system on behalf of their employees -- and in some states may be eligible for unemployment insurance themselves -- unincorporated business owners generally don’t participate, Stevenson said.

Seven states -- Delaware, Maine, Maryland, New Jersey, New York, Oregon and Pennsylvania -- also offer a self-employment- assistance program, which provides unemployed people with money and training for as many as 26 weeks to start a businesses.

Even so, such programs can’t overcome the “extraordinarily large” gap between what the U.S. economy should be and is producing, as well as an environment that is “less forgiving” for mistakes, Stevenson said. “People may have a good idea and they’d be quite capable of implementing it, but small mistakes early on can be heavily punished in a bad economy.”

‘Return to Normal’

Woodward says a large portion of start-up failures may be a “return to normal.” Historically, entrepreneurs represented about 10.5 percent of all employment in the U.S. economy, she said. Beginning in 2003, this rose as high as 11.3 percent before falling to the historical average earlier this year. So she’s “less alarmed” about the long-term implications for the vibrancy of small-business activity.

Some entrepreneurs actually are thriving, Arslan said. Those who get approved as state or federal contractors are doing very well, as are business owners who work in healthcare and information technology, she said.

Small companies still face challenges, including access to financing and rising health-insurance costs, along with their exposure to struggling industries, Shane said.

“It’s no wonder entrepreneurs aren’t doing very well,” Shane said. “And no wonder they’re not adding very many jobs to the economy.”

--Editors: Melinda Grenier, Gail DeGeorge

IRS allowed $4.2 billion in credits to undocumented workers, audit says

2011-09-02T10:08:00.000-05:00

By Charles S. Clark

Undocumented workers received refundable tax credits totaling $4.2 billion in 2010, a dramatic rise from less than $1 billion in 2005, said a report released Thursday by the Treasury Inspector General for Tax Administration. The Internal Revenue Service, however, said it lacks the authority to disallow claims for the credit and a clarification of oftentimes controversial immigration policy might be needed.

At issue is use of a tax break based on earned income called the additional child tax credit, which taxpayers can claim to reduce their taxes owed, sometimes gaining them a check from Uncle Sam if their tax obligation goes below zero.

Wage earners who are not authorized to work in the United States and lack Social Security numbers can use what IRS calls individual taxpayer identification numbers, which, data show, are associated with a higher proportion of fraudulent claims on tax returns. "The payment of federal funds through this tax benefit appears to provide an additional incentive for aliens to enter, reside and work in the United States without authorization, which contradicts federal law and policy," the report said.

Though undocumented workers are not eligible for federal benefits or the commonly claimed earned income tax credit, federal law is unclear, TIGTA said, on whether such workers who file tax returns qualify for refundable credits such as the additional child credit.

"Clarification is needed on this issue," said J. Russell George, Treasury inspector general for tax administration, saying IRS should work with the Treasury Department to clear up whether this child credit should be paid. The report also said the IRS should begin requiring those claiming the credit to document their eligibility.

IRS managers, in their response to a draft of the report, agreed to take up the issue with Treasury, but disagreed with TIGTA's recommendation on requiring documentation. The revenue agency has no legal authority to demand such documentation during the processing of a tax return, they said. The IRS can only do so during an individualized examination.

The murkiness of the issue reflects a long-standing broader dispute over who is responsible for enforcing immigration law. In the words of a former IRS commissioner quoted by TIGTA, "the IRS' job is to make sure that everyone who earns income within our borders pays the proper amount of taxes, even if they may not be working here legally."

How the agencies might handle the question divides advocacy groups in the larger immigration debate. Jonathan Blazer, staff attorney in the Oakland, Calif., office of the National Immigration Law Center, which defends many low-income immigrants, said, "Our tax system generally doesn't differentiate between citizens or immigrants or immigrants of differing immigration status, and no worker is given a free pass from the obligation to pay tax."

He thinks TIGTA is "one-sided in getting all up in arms because this credit is being claimed by one population." If one considers the context, Blazer said, undocumented immigrants contribute billions of dollars to the Social Security and Medicare trust funds, and even the IRS has documented the billions such workers contribute in overall taxes.

"If Treasury wants to reconsider promotion of tax compliance," he added, it should also consider "the consequences for all taxpayers, the major burden that citizenship inquiries would impose on taxpayers, tax preparers and the IRS."

Ira Mehlman, media director for the Federation for American Immigration Reform, which favors a crackdown on illegal immigration, offered a contrary view. "Treasury thinks IRS does have the authority" to fix the problem, but "IRS management doesn't want to exercise it," he said. "Setting aside fact that we're getting ripped off to the tune of $4.2 billion, there's a seeming lack of concern by agencies that are here to protect us."

Mehlman's group opposes refundable tax credits for workers who are in the country illegally, and he called it "astounding" that TIGTA audit data show 72 percent of tax returns using individual taxpayer identification numbers claimed the child tax credit. "Treasury should be able to call the IRS commissioner in" and tell him not to pay illegal immigrants refundable tax credits, "especially since we're running a deficit," Mehlman said. "If that doesn't work, that's what congressional oversight is for."

Management Accountants: The People Businesses Need Now More Than Ever

2011-09-01T09:22:00.002-05:00

The impact of regional economies over global financial markets is intense. This past month was particularly tumultuous as investors reacted to current events and economic conditions in Europe, Asia and the U.S. The rocky ride has organizations struggling to maintain the inroads they’ve made over the last two years. Corporations must navigate the risks and opportunities to move forward. That’s why I think there is great potential for management accountants to lead businesses toward success in the future.

What makes me so optimistic? Because the skill sets of management accountants have never been more appropriate for business success. In addition to solid accounting fundamentals, management accountants’ competencies in monitoring, assessing and forecasting performance; helping colleagues understand income and costs; and assisting management in making tough decisions are critical for organizations to move in the right strategic direction.

The AICPA and the Chartered Institute of Management Accountants are preparing for the early 2012 launch of the Chartered Global Management Accountant designation. The CGMA will showcase the management accounting expertise of qualified AICPA voting members, and open up an international community of colleagues for sharing ideas and gaining knowledge. The targeted resources and continuous learning opportunities that the AICPA and CIMA are preparing will enhance CGMA holders’ business acumen and help them bring long term value to their organizations. I am excited to be a part of this effort to establish what will be a gold standard for management accountants worldwide. If you want to learn more about what the CGMA, visit the CGMA website.

Carol Scott, CPA, Vice President - Business, Industry and Government, American Institute of CPAs.

The link to this article is: http://blog.aicpa.org/2011/08/management-accountants-the-people-businesses-need-now-more-than-ever.html

Give Payroll Tax Cuts to Employers, Not Employees

2011-09-01T09:20:00.000-05:00

Rather than extend the employee payroll tax cut, the government should give reductions to employers that hire workers. This will do more to boost job creation.

By Scott Shane

In his most recent weekly radio address, President Obama proposed extending the 2011 employee payroll tax cut for another year, reiterating his argument that it will create jobs. I disagree and don’t think it’s worth extending. While Treasury Secretary Timothy Geithner claimed back in January that the payroll tax cut would create 1.5 million new jobs, Joel Prakken of Macroeconomic Advisors says it has created only 300,000, and other observers estimate the number is even lower.

When paying payroll taxes, employers and employees are normally each responsible for half of the 12.4 percent Social Security tax. Last December, Congress passed the President’s proposal to reduce the workers’ share of Social Security taxes to 4.2 percent for 2011. The employer’s share of the taxes remained 6.2 percent, giving them no additional incentive to hire.

If Congress and the Administration want business owners—particularly the small business owners who employ half the private-sector workers in this country—to increase hiring, then they should let the employee payroll tax reduction expire at the end of the year and replace it with an employer-side payroll tax reduction. As the nonpartisan Congressional Budget Office explained to Congress in a January 2010 report, payroll tax cuts boost employment more if they are given to employers rather than employees.

Job Creators Only?

But there may be an even better way of stimulating job growth than an across-the-board payroll tax cut for employers. Some economists have suggested limiting the employer payroll tax cut to only those businesses that create new jobs. There’s a lot of merit in that approach.

Because a targeted tax cut would cost much less than a tax cut for all businesses, lawmakers could reduce payroll taxes on the businesses adding jobs by much more than the 2 percent across-the-board reductions put in place for employees this year. In fact, policymakers could eliminate the entire 6.2 percent employer share of payroll taxes and contribute less to the deficit simply by limiting the tax cut to the businesses boosting hiring.

In addition to wiping out the employer share of payroll taxes, policymakers should offer a tax credit equal to 25 percent of the increase in payrolls, but limit the credit to only those firms that hire more workers. If nearly one-third the cost of new employees was being picked up by the government, businesses would add workers.

Small Biz Incentive

The credit would be meaningful to small business owners who run pass-through businesses where profits and losses are treated as personal income (sole proprietorships and subchapter S corporations). Because the cost of additional hires hits the wallets of these business owners, cutting the cost of those workers would be a powerful incentive.

While the economics of a targeted payroll tax cut for employers is sound, I’m not sure the Administration would go for it. What the Obama Administration liked about the employee payroll tax cut was that the money went to all employed Americans. As ineffective as the policy was at stimulating job creation, cutting taxes on the average American is politically very attractive. A targeted tax cut for only those businesses adding employees, however, goes largely to the successful business owners (they’re the ones most likely to hire).

The New York Times reports that President Obama “is considering expanding payroll-tax relief to employers and a tax credit for new hires.” That’s promising. Of course, I wonder if it will really happen.

Scott Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University.

Natural Disasters and Your Taxes

2011-08-31T10:48:00.000-05:00

Hit by Irene? You might have a tax deduction or an unexpected tax gain.

By BILL BISCHOFF

While Hurricane Irene turned out to be milder than expected, it still caused deaths, injuries and an estimated $5 billion to $7 billion in property damage. And Irene was not the only big problem this year. In the spring we had devastating tornadoes in Missouri and widespread flooding in the Midwest. The sad truth: natural disasters occur every year in the U.S. because this is a big country. If you're unlucky enough to suffer a disaster-related casualty, here's what you need to know about the federal income tax implications.

Deductions for Personal Casualty Losses

Theoretically, our beloved Internal Revenue Code allows you to claim an itemized deduction on your Form 1040 -- for personal casualty losses that are not covered by insurance. Exactly what is a casualty loss? It's when the fair market value of your property or asset is reduced or wiped out by a hurricane, flood, storm, fire, earthquake or volcanic eruption (not to mention sonic boom, theft, or vandalism).

In reality, however, many disaster victims won't qualify for any personal casualty loss write-offs because of the following two rules. First you must reduce your loss by $100. Then you must further reduce the loss by an amount equal to 10% of your adjusted gross income (AGI) for the year. Say you incur a $10,000 personal casualty loss this year and have AGI of $80,000. Your write-off is a puny $1,900 ($10,000 - $100 - $8,000). You get absolutely no tax break if your loss is $8,100 or less, and you have no chance at all if you don't itemize.

But let's assume you do have a 2011 deductible personal casualty loss after the two reductions. If the loss was caused by a disaster in a federally declared disaster area (more on that later), a special rule allows you to claim your rightful deduction either this year or last year. For example, victims of Hurricane Irene can file amended 2010 returns and claim their losses last year. And if you extended your 2010 return to October 17, 2011, you can claim the loss on your original return for last year filed by that date. This rule allows you to get some immediate tax savings instead of having to wait until 2012 when you finally get around to filing your 2011 return. Remember: this special rule is only available for losses in federally declared disaster areas. You can find a by-state listing of these areas on the Federal Emergency Management Agency (FEMA) website at www.fema.gov .

Deductions for Business Casualty Losses

If you have disaster-related losses to business assets, you don't have to worry about the $100 reduction rule or the 10%-of-AGI reduction rule. Instead, you can deduct the full amount of your uninsured loss as a business expense. As with personal casualty losses, you have the option of claiming 2010 deductions for 2011 losses that occur in a federally declared disaster area.

Watch Out: You Might Have a Taxable Gain

When you have insurance coverage for disaster-related property damage (such as under a homeowners, renters, or business policy), you're almost as likely to have a taxable gain as a deductible casualty loss. Why? Because if the insurance proceeds exceed the tax basis of the damaged or destroyed property, you have a taxable profit as far as the Internal Revenue Service is concerned. This is the case even when the insurance doesn't compensate you for the full pre-casualty value of the property or asset. These insurance-caused gains are called involuntary conversion gains (because your asset is suddenly converted into cash insurance proceeds without you having any say about it).

If you do turn out to have an involuntary conversion gain, it must be reported on your tax return unless you: (1) make sufficient expenditures to repair or replace the property and (2) make a special tax election to defer the gain. If you make the election (you generally should), you have a taxable gain only to the extent the insurance proceeds exceed what you spend to repair or replace the property. The expenditures for repairs or replacement generally must occur within the period beginning on the date the property was damaged or destroyed and ending two years after the close of the tax year in which you have the involuntary conversion gain.

Special favorable rules apply to involuntary conversion gains resulting from casualties in presidentially declared disaster areas (the rules are way too complicated to adequately explain here).

For more details on disaster-related casualties and your taxes, see IRS Publication 547 (Casualties, Disasters, and Thefts) at www.irs.gov. If you have big losses or big insurance payments, consider hiring a tax pro (like me) to deal with the complicated rules and prepare your return. It could be money well-spent.

Keep Good Records Now to Reduce Tax-Time Stress

2011-08-26T14:43:00.000-05:00

You may not be thinking about your tax return right now, but summer is a great time to start planning for next year. Organized records not only make preparing your return easier, but may also remind you of relevant transactions, help you prepare a response if you receive an IRS notice, or substantiate items on your return if you are selected for an audit.

Here are a few things the IRS wants you to know about recordkeeping.

1. In most cases, the IRS does not require you to keep records in any special manner. Generally, you should keep any and all documents that may have an impact on your federal tax return. It’s a good idea to have a designated place for tax documents and receipts.

2. Individual taxpayers should usually keep the following records supporting items on their tax returns for at least three years:

• Bills;

• Credit card and other receipts;

• Invoices;

• Mileage logs;

• Canceled, imaged or substitute checks or any other proof of payment;

• Any other records to support deductions or credits you claim on your return.

You should normally keep records relating to property until at least three years after you sell or otherwise dispose of the property. Examples include:

• A home purchase or improvement;

• Stocks and other investments;

• Individual Retirement Arrangement transactions;

• Rental property records.

3. If you are a small business owner, you must keep all your employment tax records for at least four years after the tax becomes due or is paid, whichever is later. Examples of important documents business owners should keep include:

• Gross receipts: Cash register tapes, bank deposit slips, receipt books, invoices, credit card charge slips and Forms 1099-MISC;

• Proof of purchases: Canceled checks, cash register tape receipts, credit card sales slips and invoices;

• Expense documents: Canceled checks, cash register tapes, account statements, credit card sales slips, invoices and petty cash slips for small cash payments;

• Documents to verify your assets: Purchase and sales invoices, real estate closing statements and canceled checks.

For more information about recordkeeping, check out IRS Publication 552, Recordkeeping for Individuals, Publication 583, Starting a Business and Keeping Records, and Publication 463, Travel, Entertainment, Gift, and Car Expenses. These publications are available at www.IRS.gov or by calling 800-TAX-FORM (800-829-3676).

If you need help with your recordkeeping (bookkeeping and accounting services), please contact me (Ken Reid) directly at 773-792-1910 or by email at mastertype@mabspc.com.