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. §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. §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. §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).
Tuesday, November 22, 2011
Worker Misclassification Issues
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.
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
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.
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
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.
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
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
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.)
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.)
Monday, November 21, 2011
Tax Professionals Urged to Prepare for New e-File Rules
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
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
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
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
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
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
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
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
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.
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
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
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
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
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
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
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
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 ‘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
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 ‘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
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
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
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
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
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
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
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.
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
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.
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
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.
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.
Wednesday, November 9, 2011
GOP makes new offer on taxes, Medicare cuts
'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."
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."
Thursday, November 3, 2011
IRS Issues Further Guidance on Exams Involving Uncertain Tax Positions
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.
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
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.
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.
Wednesday, November 2, 2011
IRS Announces Pension Plan Limitations for 2012
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.
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.
Wednesday, October 26, 2011
IRS Proposes Regulations Eliminating De Minimis Partner Rule (NRPM REG-109564-10)
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
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
Wednesday, October 19, 2011
3 Tax-Savings Deals at Your Job
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.
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.
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