Erin Schlichting is happy to announce she will be adding a new partner to her team.  The firm name will change to Schlichting Wixson PLLC.  Wendy Wixson, a CPA with 20 years of experience, is an international tax expert who consults with companies all over the world.

Copy and paste this link into your browser to see information about the new Health Care Exchanges on the US Department of Health and Human Services web page:

http://www.hhs.gov/news/press/2013pres/06/20130624a.html

Written by Paul Bonner who is a Journal of Accountancy senior editor and Alistair M. Nevius who is the Journal of Accountancy’s editor-in-chief, tax.

Pulling back from the “fiscal cliff” at the 13th hour, Congress on Tuesday preserved most of the George W. Bush-era tax cuts and extended many other lapsed tax provisions.

Shortly before 2 a.m. Tuesday, the Senate passed a bill that had been heralded and, in some quarters, groused about throughout the preceding day. By a vote of 89 to 8, the chamber approved the American Taxpayer Relief Act, H.R. 8, which embodied an agreement that had been hammered out on Sunday and Monday between Vice President Joe Biden and Senate Minority Leader Sen. Mitch McConnell, R-Ky. The House of Representatives approved the bill by a vote of 257–167 late on Tuesday evening, after plans to amend the bill to include spending cuts were abandoned. The bill now goes to President Barack Obama for his signature.

“The AICPA is pleased that Congress has reached an agreement,” said Edward Karl, vice president–Tax for the AICPA. “The uncertainty of the tax law has unnecessarily impeded the long-term tax and cash flow planning for businesses and prevented taxpayers from making informed decisions. The agreement should also allow the IRS and commercial software vendors to revise or issue new tax forms and update software, and allow tax season to begin with minimal delay.”

With some modifications targeting the wealthiest Americans with higher taxes, the act permanently extends provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16 (EGTRRA), and Jobs and Growth Tax Relief Reconciliation Act of 2003, P.L. 108-27 (JGTRRA). It also permanently takes care of Congress’s perennial job of “patching” the alternative minimum tax (AMT). It  temporarily extends many other tax provisions that had lapsed at midnight on Dec. 31 and others that had expired a year earlier.

The act’s nontax features include one-year extensions of emergency unemployment insurance and agricultural programs and yet another “doc fix”  postponement of automatic cuts in Medicare payments to physicians. In addition, it delays until March a broad range of automatic federal spending cuts known as sequestration that otherwise would have begun this month.

Among the tax items not addressed by the act was the temporary lower 4.2% rate for employees’ portion of the Social Security payroll tax, which was not extended and has reverted to 6.2%.

Here are the act’s main tax features:

Individual tax rates

All the individual marginal tax rates under EGTRRA and JGTRRA are retained (10%, 15%, 25%, 28%, 33%, and 35%). A new top rate of 39.6% is imposed on taxable income over $400,000 for single filers, $425,000 for head-of-household filers, and $450,000 for married taxpayers filing jointly ($225,000 for each married spouse filing separately).

Phaseout of itemized deductions and personal exemptions

The personal exemptions and itemized deductions phaseout is reinstated at a higher threshold of $250,000 for single taxpayers, $275,000 for heads of household, and $300,000 for married taxpayers filing jointly.

Capital gains and dividends

A 20% rate applies to capital gains and dividends for individuals above the top income tax bracket threshold; the 15% rate is retained for taxpayers in the middle brackets. The zero rate is retained for taxpayers in the 10% and 15% brackets.

Alternative minimum tax

The exemption amount for the AMT on individuals is permanently indexed for inflation. For 2012, the exemption amounts are $78,750 for married taxpayers filing jointly and $50,600 for single filers. Relief from AMT for nonrefundable credits is retained.

Estate and gift tax

The estate and gift tax exclusion amount is retained at $5 million indexed for inflation ($5.12 million in 2012), but the top tax rate increases from 35% to 40% effective Jan. 1, 2013. The estate tax “portability” election, under which, if an election is made, the surviving spouse’s exemption amount is increased by the deceased spouse’s unused exemption amount, was made permanent by the act.

Permanent extensions

Various temporary tax provisions enacted as part of EGTRRA were made permanent. These include:

• Marriage penalty relief (i.e., the increased size of the 15% rate bracket (Sec. 1(f)(8)) and increased standard deduction for married taxpayers filing jointly (Sec. 63(c)(2));
• The liberalized child and dependent care credit rules (allowing the credit to be calculated based on up to $3,000 of expenses for one dependent or up to $6,000 for more than one) (Sec. 21);
• The exclusion for National Health Services Corps and Armed Forces Health Professions Scholarships (Sec. 117(c)(2));
• The exclusion for employer-provided educational assistance (Sec. 127);
• The enhanced rules for student loan deductions introduced by EGTRRA (Sec. 221);
• The higher contribution amount and other EGTRRA changes to Coverdell education savings accounts (Sec. 530);
• The employer-provided child care credit (Sec. 45F);
• Special treatment of tax-exempt bonds for education facilities (Sec 142(a)(13));
• Repeal of the collapsible corporation rules (Sec. 341);
• Special rates for accumulated earnings tax and personal holding company tax (Secs. 531 and 541); and
• Modified tax treatment for electing Alaska Native Settlement Trusts (Sec. 646).

Individual credits expired at the end of 2012

The American opportunity tax credit for qualified tuition and other expenses of higher education was extended through 2018. Other credits and items from the American Recovery and Reinvestment Act of 2009, P.L. 111-5, that were extended for the same five-year period include enhanced provisions for the child tax credit under Sec. 24(d) and the earned income tax credit under Sec. 32(b). In addition, the bill permanently extends a rule excluding from taxable income refunds from certain federal and federally assisted programs (Sec. 6409).

Individual provisions expired at the end of 2011

The act also extended through 2013 a number of temporary individual tax provisions, most of which expired at the end of 2011:

• Deduction for certain expenses of elementary and secondary school teachers (Sec. 62);
• Exclusion from gross income of discharge of qualified principal residence indebtedness (Sec. 108);
• Parity for exclusion from income for employer-provided mass transit and parking benefits (Sec. 132(f));
• Mortgage insurance premiums treated as qualified residence interest (Sec. 163(h));
• Deduction of state and local general sales taxes (Sec. 164(b));
• Special rule for contributions of capital gain real property made for conservation purposes (Sec. 170(b));
• Above-the-line deduction for qualified tuition and related expenses (Sec. 222); and
• Tax-free distributions from individual retirement plans for charitable purposes (Sec. 408(d)).

Business tax extenders

The act also extended many business tax credits and other provisions. Notably, it extended through 2013 and modified the Sec. 41 credit for increasing research and development activities, which expired at the end of 2011. The credit is modified to allow partial inclusion in qualified research expenses and gross receipts those of an acquired trade or business or major portion of one. The increased expensing amounts under Sec. 179 are extended through 2013. The availability of an additional 50% first-year bonus depreciation (Sec. 168(k)) was also extended for one year by the act. It now generally applies to property placed in service before Jan. 1, 2014 (Jan. 1, 2015, for certain property with longer production periods).

Other business provisions extended through 2013, and in some cases modified, are:

• Temporary minimum low-income tax credit rate for non-federally subsidized new buildings (Sec. 42);
• Housing allowance exclusion for determining area median gross income for qualified residential rental project exempt facility bonds (Section 3005 of the Housing Assistance Tax Act of 2008);
• Indian employment tax credit (Sec. 45A);
• New markets tax credit (Sec. 45D);
• Railroad track maintenance credit (Sec. 45G);
• Mine rescue team training credit (Sec. 45N);
• Employer wage credit for employees who are active duty members of the uniformed services (Sec. 45P);
• Work opportunity tax credit (Sec. 51);
• Qualified zone academy bonds (Sec. 54E);
• Fifteen-year straight-line cost recovery for qualified leasehold improvements, qualified restaurant buildings and improvements, and qualified retail improvements (Sec. 168(e)); Accelerated depreciation for business property on an Indian reservation (Sec. 168(j));
• Enhanced charitable deduction for contributions of food inventory (Sec. 170(e));
• Election to expense mine safety equipment (Sec. 179E);
• Special expensing rules for certain film and television productions (Sec. 181);
• Deduction allowable with respect to income attributable to domestic production activities in Puerto Rico (Sec. 199(d));
• Modification of tax treatment of certain payments to controlling exempt organizations (Sec. 512(b));
• Treatment of certain dividends of regulated investment companies (Sec. 871(k));
• Regulated investment company qualified investment entity treatment under the Foreign Investment in Real Property Act (Sec. 897(h));
• Extension of subpart F exception for active financing income (Sec. 953(e));
• Lookthrough treatment of payments between related controlled foreign corporations under foreign personal holding company rules (Sec. 954);
• Temporary exclusion of 100% of gain on certain small business stock (Sec. 1202);
• Basis adjustment to stock of S corporations making charitable contributions of property (Sec. 1367);
• Reduction in S corporation recognition period for built-in gains tax (Sec. 1374(d));
• Empowerment Zone tax incentives (Sec. 1391);
• Tax-exempt financing for New York Liberty Zone (Sec. 1400L);
• Temporary increase in limit on cover-over of rum excise taxes to Puerto Rico and the Virgin Islands (Sec. 7652(f)); and American Samoa economic development credit (Section 119 of the Tax Relief and Health Care Act of 2006, P.L. 109-432, as modified).

Energy tax extenders

The act also extends through 2013, and in some cases modifies, a number of energy credits and provisions that expired at the end of 2011:

• Credit for energy-efficient existing homes (Sec. 25C);
• Credit for alternative fuel vehicle refueling property (Sec. 30C);
• Credit for two- or three-wheeled plug-in electric vehicles (Sec. 30D);
• Cellulosic biofuel producer credit (Sec. 40(b), as modified);
• Incentives for biodiesel and renewable diesel (Sec. 40A);
• Production credit for Indian coal facilities placed in service before 2009 (Sec. 45(e)) (extended to an eight-year period);
• Credits with respect to facilities producing energy from certain renewable resources (Sec. 45(d), as modified);
• Credit for energy-efficient new homes (Sec. 45L);
• Credit for energy-efficient appliances (Sec. 45M);
• Special allowance for cellulosic biofuel plant property (Sec. 168(l), as modified);
• Special rule for sales or dispositions to implement Federal Energy
• Regulatory Commission or state electric restructuring policy for qualified electric utilities (Sec. 451); and
• Alternative fuels excise tax credits (Sec. 6426).

Foreign provisions

The IRS’s authority under Sec. 1445(e)(1) to apply a withholding tax to gains on the disposition of U.S. real property interests by partnerships, trusts, or estates that are passed through to partners or beneficiaries that are foreign persons is made permanent, and the amount is increased to 20%.

New taxes

In addition to the various provisions discussed above, some new taxes also took effect Jan. 1 as a result of 2010’s health care reform legislation.

Additional hospital insurance tax on high-income taxpayers. The employee portion of the hospital insurance tax part of FICA, normally 1.45% of covered wages, is increased by 0.9% on wages that exceed a threshold amount. The additional tax is imposed on the combined wages of both the taxpayer and the taxpayer’s spouse, in the case of a joint return. The threshold amount is $250,000 in the case of a joint return or surviving spouse, $125,000 in the case of a married individual filing a separate return, and $200,000 in any other case.

For self-employed taxpayers, the same additional hospital insurance tax applies to the hospital insurance portion of SECA tax on self-employment income in excess of the threshold amount.

Medicare tax on investment income.

For married individuals filing a joint return and surviving spouses, the threshold amount is $250,000; for married taxpayers filing separately, it is 125,000; and for other individuals it is $200,000.

Net investment income means investment income reduced by deductions properly allocable to that income. Investment income includes income from interest, dividends, annuities, royalties, and rents, and net gain from disposition of property, other than such income derived in the ordinary course of a trade or business. However, income from a trade or business that is a passive activity and from a trade or business of trading in financial instruments or commodities is included in investment income.

Medical care itemized deduction threshold.

The threshold for the itemized deduction for unreimbursed medical expenses has increased from 7.5% of AGI to 10% of AGI for regular income tax purposes. This is effective for all individuals, except, in the years 2013–2016, if either the taxpayer or the taxpayer’s spouse has turned 65 before the end of the tax year, the increased threshold does not apply and the threshold remains at 7.5% of AGI.

Health flexible spending arrangement.

Effective for cafeteria plan years beginning after Dec. 31, 2012, the maximum amount of salary reduction contributions that an employee may elect to have made to a flexible spending arrangement for any plan year is $2,500.

The IRS has released the 2013 optional standard mileage rates that employees, self-employed individuals, and other taxpayers can use to compute deductible costs of operating automobiles (including vans, pickups and panel trucks) for business, medical,  moving and charitable purposes.

The 2013 standard mileage rate is increased to 56.5 cents per mile for business uses and 24 cents per mile for medical and moving uses. It remains at 14 cents per mile for charitable uses. For purposes of computing the allowance under an FAVR plan,  the standard automobile cost may not exceed $28,100 ($29,900 for trucks and vans). The updated rates are effective for deductible  transportation expenses paid or incurred on or after January 1, 2013, and for mileage allowances or reimbursements paid  to,  or transportation expenses paid or incurred by, an employee or a charitable volunteer on or after January 1, 2013.

In recent years, end-of-the-year tax planning for businesses has been complicated by uncertainty over the future availability of any tax incentives. This year is no different.  In 2010, Congress extended many business tax incentives for one or two years.  Now, those incentives have expired or are scheduled to expire. Whether they will be extended beyond 2012 is unclear as Congress debates with the fate of the fate of the Bush-era tax cuts and across-the-board spending cuts scheduled to take effect in 2013. In the meantime, you need to be aware of the expiring provisions and explore developing a multiyear tax strategy that takes into account various scenarios for the future of these incentives.

Code Sec. 179 expensing.  Code Sec. 179 gives businesses the option of claiming a deduction for the cost of qualified property all in its first year of use rather than claiming depreciation over a period of years. For 2010 and 2011, the Code Sec. 179 dollar limitation was $500,000 with a $2 million investment ceiling. For 2012, the amounts are less generous. The dollar limitation for 2012 is $139,000 with a $560,000 investment ceiling. Under current law, the Code Sec. 179 dollar limit is scheduled to drop to $25,000 for 2013 with a $200,000 investment ceiling.

Businesses should consider accelerating purchases into 2012 to take advantage of the still generous Code Sec. 179 expensing. Qualified property must be tangible personal property, which you actively use in your business, and for which a depreciation deduction would be allowed. Qualified property must be newly purchased new or used property, rather than property you previously owned but recently converted to business use. Examples of types of property that would qualify for Code Sec. 179 expensing are office equipment or equipment used in the manufacturing process. Additionally, Code Sec. 179 expensing is allowed for off-the-shelf computer software placed in service in tax years beginning before 2013.

If your equipment purchases for the year exceed the expensing dollar limit, you can decide to split your expensing election among the new assets any way you choose. If you have a choice, it may be more valuable to expense assets with the longest depreciation periods. As long as you start using your newly purchased business equipment before the end of the tax year, you get the entire expensing deduction for that year. The amount that can be expensed depends upon the date the qualified property is placed in service; not when the qualified property is purchased or paid for.

Dividends. Under current law, tax-favorable dividends tax rates are scheduled to expire after 2012. Qualified dividends are eligible for a maximum 20 percent tax rate for taxpayers in the 25 percent and higher brackets; zero percent for taxpayers in the 10 and 15 percent brackets. In July, the House voted to extend the current dividend tax treatment through 2013. The Senate, however, voted to extend the tax favorable rates only for individuals with incomes below $200,000 (families with incomes below $250,000). For income in excess of $200,000/$250,000 the tax rate on capital gains and dividends would be 20  percent.

Expired business tax incentives.  Many temporary business tax incentives expired at the end of 2011. In past years,  Congress has routinely extended these incentives, often retroactively, but this year may be different. Confronted with the federal budget deficit and across-the-board spending cuts scheduled to take effect in 2013, lawmakers allow some of the business tax extenders to expire permanently. Certain extenders, however, have bipartisan support, and are likely to be extended.  They include the Code Sec. 41 research tax credit, the Work Opportunity Tax Credit (WOTC), and 15-year recovery period for leasehold, restaurant and retail improvement property.

Small employer health insurance credit.  A potentially valuable tax incentive has often been overlooked by small businesses, according to reports. Employers with 10 or fewer full-time employees (FTEs) paying average annual wages of not more than $25,000 may be eligible for a maximum tax credit of 35 percent on premiums paid for tax years beginning in 2010 through 2013. Tax-exempt employers may be eligible for a maximum tax credit of 25 percent for tax years beginning in 2010 through 2013.

 

The IRS has issued the simplified per diem rates that taxpayers can use to reimburse employees for expenses incurred during business travel after September 30, 2012 (Notice 2012-63, 2012-42 IRB __). The high-low per diems for 2013 remain unchanged from 2012 at $242 for high-cost localities and $163 for all other localities. Additionally, certain expenses are no longer included in the definition of incidental expenses.

Generally, per diem amounts approved by the IRS track the federal per diem rates published by the General Services Administration for travel within the continental United States by federal government employees on official business. In August, the GSA announced that the 2013 federal per diem rates would be unchanged from 2012. GSA explained that the rates were frozen in response to a White House directive requiring federal agencies to spend at least 30 percent less on travel expenses than in fiscal year 2010 through fiscal year 2016. “By keeping per diem rates at current levels, we are supporting federal agencies in controlling costs and ensuring that taxpayer dollars are used wisely,” GSA Acting Administrator Dan Tangherlini said in a statement.

Comment

The IRS announced in Rev. Proc. 2011-47, 2011-42 IRB 520, that going forward it would not revise the annual revenue procedure that provides rules for using a per diem rate to substantiate the amount of an employee’s expenses for lodging, meal and incidental expenses, or for meal and incidental expenses only, that a payor reimburses. Instead, the IRS would publish, as it has this year, an annual notice providing the special per diem rates and the list of high-cost localities.

Incidental expenses. The rate for the incidental-expenses-only deduction is $5 per day for post-September 30, 2012 travel, which is unchanged from the previous rate. In Rev. Proc. 2011-47, the IRS explained that the term “incidental expenses” has the same meaning as in the federal travel regulations. The federal travel regulations issued by GSA in 2011 describe incidental expenses as fees and tips given to porters, baggage carriers, bellhops, hotel maids, stewards or stewardesses and others on ships. Transportation between places of lodging or business and places where meals are taken and the mailing cost associated with filing travel vouchers and payment of employer-sponsored charge card billings are excluded from definition of incidental expenses. As a result, taxpayers using per diem rates may separately deduct or be reimbursed for transportation and mailing expenses.

High-low method.The IRS-approved per diem rate for high-cost areas is $242 ($177 for lodging and $65 for meals and incidental expenses). The IRS-approved per diem rate for all other areas is $163 ($111 for lodging and $52 for meals and incidental expenses). The rates apply to per diem allowances paid for travel after September 30, 2012. Besides the high-low per diem rates remaining the same, the list of high-cost localities is also unchanged from 2012.

Transportation-industry per diem.The IRS-approved meal and incidental expenses rate for taxpayers in the transportation industry is $59 for all localities within the CONUS and $65 for all localities outside the CONUS.

2012 began with great uncertainty over federal tax policy and now, with the end of the year approaching, that uncertainty appears to be far from any long-term resolution. As the year draws to a close, many taxpayers are asking how they can plan in light of the uncertainty surrounding the fate of the Bush-era tax cuts and other expiring tax incentives.

A host of reduced tax rates, credits, deductions, and other incentives (collectively called the “Bush-era” tax cuts) are scheduled to expire after December 31, 2012. To further complicate planning, over 50 tax extenders are up for renewal, either having expired at the end of 2011 or which are scheduled to expire after 2012. At the same time, the federal government will be under sequestration, which imposes across-the-board spending cuts after 2012. The combination of all these events has many referring to 2013 as “taxmaggedon.”

Expiring Incentives

Effective January 1, 2013, the individual income tax rates, without further congressional action, are scheduled to increase across-the-board, with the highest rate jumping from 35 percent to 39.6 percent. The current 10-percent rate will expire and marriage-penalty relief will sunset. Additionally, the current tax-favorable capital gains and dividends tax rates (15 percent for taxpayers in the 25-percent bracket rate and above, and 0 percent for all other taxpayers) are scheduled to expire. Higher-income taxpayers will also be subject to revived limitations on itemized deductions and their personal exemptions. The child tax credit, one of the most popular incentives in the Code, will be cut in half. Millions of taxpayers would be liable for the alternative minimum tax because of expiration of the AMT “patch.” (Note that the AMT patch also has not been extended for the 2012 tax year.) Countless other incentives for individuals may either disappear or be substantially reduced after 2012. While a divided Congress may indeed act to prevent some or all of these tax increases, a year-end planning strategy that protects against worst-case scenarios may be especially wise to consider this year.

Year-End Planning

Income tax withholding. Expiration of the reduced individual tax rates will have an immediate impact. Income tax withholding on payrolls will immediately reflect the increased rates. One strategy for taxpayers to avoid being surprised in 2013 is to adjust income tax withholding. Keep in mind that the current 2-percent payroll tax holiday is also scheduled to expire after 2012, so it is a good time to review if a taxpayer is having too much or too little federal income tax withheld from pay.

As mentioned, traditional year-end planning techniques should be considered along with some variations on those strategies. Instead of shifting income into a future year, taxpayers may want to recognize income in 2012, when lower tax rates are available, rather than shift income to 2013. Another valuable year-end strategy is to run the numbers for regular tax liability and AMT liability. Taxpayers may want to explore whether certain deductions should be more evenly divided between 2012 and 2013 and which deductions may qualify, or will not be as valuable, for AMT purposes.

Harvesting losses. Now is also a good time to consider loss-harvesting strategies to offset current gains or to accumulate losses to offset future gains (which may be taxed at a higher rate). The first consideration is to identify whether an investment qualifies for either a short-term or long-term capital gains status, because short-term gains are first offset with short-term losses and long-term gains with long-term losses. Remember also that the wash-sale rule generally prohibits taxpayers from claiming a tax-deductible loss on a security if the taxpayer repurchases the same or a substantially identical asset within 30 days of the sale.

Education expenses. Taxpayers with higher educational expenses may want to consider the scheduled expiration of the American opportunity tax credit after 2012 in their plans. The AOTC (an enhanced version of the Hope education credit) reaches the sum of 100 percent of the first $2,000 of qualified expenses and 25 percent of the next $2,000 of qualified expenses, subject to income limits. If possible, pre-paying 2013 educational expenses before year-end 2012 could make the expenses eligible for the AOTC before it expires. The “regular” Hope credit, and another popular education tax incentive, the Lifetime Learning credit, are not scheduled to expire after 2012.

Job search expenses. Some expenses related to a job search may be tax deductible. There is one important limitation: The expenses must be spent on a job search in the taxpayer’s current occupation. A taxpayer may not deduct expenses incurred while looking for a job in a new occupation. Examples of job search expenses are unreimbursed employment and outplacement agency fees paid while looking for a job in the taxpayer’s present occupation. Travel expenses to look for a new job may be deductible. The amount of job search expenses that may be claimed is limited. A taxpayer can claim the amount of expenses only to the extent that they, together with other miscellaneous deductions, exceed 2 percent of the taxpayer’s adjusted gross income.

Gifts. Gift-giving as a year-end tax strategy should not be overlooked. The annual gift tax exclusion per recipient for which no gift tax is due is $13,000 for 2012. Married couples may make combined tax-free gifts of $26,000 to each recipient. Use of the lifetime gift tax exclusion amount ($5.12 million for 2012) should also be considered. Without congressional action, the lifetime exclusion amount drops to $1 million in 2013.

Charitable giving. For many individuals, charitable giving is also a part of their year-end tax strategy. Under current law, the so-called “Pease limitation” (named for the member of Congress who sponsored the law) is scheduled to be revived after 2012. The Pease limitation generally requires higher income individuals to reduce their tax deductions by certain amounts, including their charitable deductions. A special rule for contributing IRA assets to a charity by individuals age 70½ and older expired after 2011 but could be renewed for 2012.

New Medicare Taxes

In 2013, two new taxes kick-in. The Patient Protection and Affordable Care Act, P.L. 111-148, imposes an additional 0.9-percent Medicare tax on wages and self-employment income and a 3.8-percent Medicare contribution tax. The 3.8-percent Medicare contribution tax will apply after 2012 to single individuals with a modified adjusted gross income in excess of $200,000 and married taxpayers with an MAGI in excess of $250,000. MAGI, for purposes of the Medicare contribution tax, includes wages, salaries, tips, and other compensation, dividend and interest income, business and farm income, realized capital gains, income from a variety of other passive activities, and certain foreign earned income. For individuals liable for the tax, the amount of tax owed will be equal to 3.8 percent multiplied by the lesser of (1) net investment income; or (2) the amount by which their MAGI exceeds the $200,000/$250,000 thresholds. Taxpayers with MAGIs below the $200,000/$250,000 thresholds will not be subject to the 3.8-percent tax.

More Changes for 2013

Many employers with health flexible spending arrangements limit salary reduction contributions to between $2,500 and $5,000. Effective 2013, the Patient Protection Act requires health FSAs under a cafeteria plan to limit contributions through salary reductions to $2,500. After 2013, the $2,500 limitation is scheduled to be adjusted for inflation. Individuals with unused health FSA dollars should consider spending them before year end, or a 2½-month grace period if applicable, to avoid the “use-it-or-lose-it” rule. Keep in mind that health FSA dollars cannot be used for over-the-counter medications (except for insulin) after 2010.

Additionally, the threshold to claim an itemized deduction for unreimbursed medical expenses increases from 7.5percent of adjusted gross income to 10 percent of AGI after 2012. The Patient Protection Act provides a temporary exception for individuals (or their medical expenses cannot be timed for tax deduction purposes, batching expenses into 2012, when the threshold is 7.5 percent, may make it more likely that the expenses will exceed that threshold.

Looking Ahead

In July 2012, the House and Senate passed competing bills to extend many of the expiring incentives one more year. Both bills would extend the current income tax rates (10, 15, 25, 28, 33, and 35 percent) through 2013. The House bill would extend the current capital gains and dividends treatment, but the Senate bill would extend the tax-favorable rates only for individuals with incomes below $200,000 (families with incomes below $250,000). For income in excess of $200,000/$250,000, the tax rate on capital gains and dividends would be 20 percent. Both bills would extend the $1,000 child tax credit through 2013 and provide for an AMT patch for 2012 (the House bill also provides an AMT patch for 2013).

At this time, it is increasingly likely that the fate of all the expiring tax provisions will be decided by the lame-duck Congress after the November elections. Although the House and Senate bills passed in July differ, they have many points in common, the most important being that lawmakers could agree on a one-year extension of the Bush-era tax cuts. However, some observers anticipate no resolution until January 2013 or beyond.

 

This article highlights some of the more important tax developments.

Health care legislation

In a 5-4 decision, the U.S. Supreme Court upheld the Patient Protection and Affordable Care Act (PPACA) and its companion law, the Health Care and Education Reconciliation Act (HCERA) on June 28, 2012 (National Federation of Independent Business et al. v. Sebelius). Chief Justice John Roberts, writing for the majority, held that the law’s individual mandate is a valid exercise of Congress’ taxing power. Four justices dissented and would have overturned the law.

Since 2010, the IRS has issued extensive guidance on the tax provisions in the health care legislation. Many of the tax provisions were effective in 2010, 2011 and 2012; but others are scheduled to take effect after 2012 and in subsequent years. These include an additional 0.9 percent Medicare tax for higher income individuals (tax years beginning after December 31, 2012), a Medicare tax of 3.8 percent on investment income for higher income individuals, trusts and estates (tax years beginning after December 31, 2012), and a higher threshold to claim an itemized deduction for unreimbursed medical expenses (tax years beginning after December 31, 2012 with a temporary waiver for individuals age 65 and older). Our office will keep you posted of developments.

Foreign bank and security accounts

The IRS announced in June streamlined procedures for U.S. citizens who are nonresidents, including dual citizens, who have failed to file U.S. income tax and information returns, such as Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR). The IRS also reported it has collected more than $5 billion from its 2009 and 2011 offshore voluntary disclosure initiatives (OVDI). The IRS reopened the 2011 OVDI in January 2012 but with less generous terms.

Corporations

In June, the IRS issued new temporary and proposed regulations on corporate inversions. The regulations remove the facts and circumstances test from regulations issued in 2009 and replace it with a bright-line rule describing the threshold of activities required for an expanded affiliated group (EAG) to have substantial business activities in the relevant foreign country. The regulations apply to transactions completed on or after June 7, 2012, the IRS explained.

Partnerships

The IRS unveiled in June a safe harbor under which it will not challenge a determination by a publicly traded partnership that income from discharge of indebtedness (cancellation of debt “COD” income) is qualifying income (passive-type income) under Code Sec. 7704(d). To benefit from the safe harbor, the COD income must result from debt incurred in activities that produce qualifying income.

Mortgage interest deduction

In May, the U.S. Tax Court found that a taxpayer who filed as married filing separately was limited to a deduction for interest paid on $500,000 of home acquisition indebtedness plus interest paid on $50,000 of home equity indebtedness (Bronstein, 138 TC No. 21). The court found that the plain language of the statute mandated this result, which is half the $1 million/$100,000 limit imposed on other taxpayers.

Deferred compensation

The IRS issued proposed regulations intended to tighten the definition of substantial risk of forfeiture (SRF) that applies to compensatory transfers of property in connection with the performance of services under Code Sec. 83 in June. As a result, fewer restrictions would qualify as an SRF.

Statute of limitations

On April 25, 2012, the U.S. Supreme Court resolved a split among the circuit courts of appeal by concluding that an overstatement of basis does not result in an omission of income for statute of limitations (SOL) purposes (Home Concrete & Supply, LLC). As a result the IRS has three years, rather than six years, to act against taxpayers who overstate basis except where fraud can be proved. The issue has arisen in a number of tax shelter cases where a taxpayer overstates basis in a partnership interest, resulting in an understatement of income.

Income

In April, a taxpayer successfully persuaded the Tax Court that her documentary film work was for-profit and not a hobby (Storey, TC Memo. 2012-115). The IRS had determined that the taxpayer, who had a full-time job as an attorney, had engaged in filmmaking without the intent to make a profit. The Tax Court found that the taxpayer had become skilled in filmmaking by attending classes, spent many hours outside of her full-time job on filmmaking and concluded that the taxpayer had a for-profit motive.

Estate tax

The IRS issued temporary and proposed regulations in June on temporary portability election for qualified estates. The portability election generally allows the estate of a deceased spouse dying after December 31, 2010 and before January 1, 2013 to transfer the decedent’s unused estate tax exclusion amount, if any, to the surviving spouse.

Local lodging expenses

In May, the IRS issued proposed reliance regulations outlining when an employee may treat local lodging expenses as working condition fringe benefits or accountable plan reimbursements; and when employers may treat qualified expenditures as deductible business expenses. The proposed regulations also provide a safe harbor for an employee to deduct local lodging expenses if certain requirements are satisfied.

Deposit interest

The IRS issued final regulations in April requiring U.S. banks and other financial institutions to report interest on deposits paid to a nonresident alien (NRA). The requirement applies to residents of any country having a tax information exchange agreement (TIEA) with the U.S. The reporting requirement applies to interest payments made on or after January 1, 2013, the IRS explained.

Health savings accounts

The IRS announced in May inflation-adjusted amounts for health savings accounts (HSAs) in 2013. For 2013, the annual contribution limit for an individual with self-only coverage under a high deductible health plan (HDHP) is $3,250 compared to $3,100 for 2012. For 2013, the annual contribution limit for an individual with family coverage under a HDHP is $6,450, compared to $6,240 for 2012. A HDHP is defined as a health plan with an annual deductible that is not less than $1,250 for self-only coverage and $2,500 for family coverage for 2013.

Fresh start initiative

The IRS announced in May an expansion of its Fresh Start initiative, designed to help taxpayers struggling financially. The IRS provided more flexible terms to its offer in compromise (OIC) program. The IRS also instructed its examiners on taxpayers’ ability to pay when student loans or state/local taxes are outstanding.

The IRS has encouraged small business owners to check out the expanded credit for hiring veterans and the credit for employer-provided health care coverage as these credits can provide significant tax benefits during 2012. The IRS has also highlighted the Voluntary Classification Settlement Program (VCSP), which is available to eligible small employers who have miss-classified their workers as independent contractors and agree to reclassify their workers as employees in the future.

Credit for Hiring Veterans

A law change enacted late in 2011 provides an expanded Work Opportunity Tax Credit (WOTC) to employers that hire eligible unemployed veterans. The credit can be as high as $9,600 per veteran for for-profit employers or up to $6,240 for tax-exempt organizations. The amount of the credit depends on a number of factors, including the length of the veteran’s unemployment before hire, hours the veteran works and the amount of first-year wages paid. Employers who hire veterans with service-related disabilities may be eligible for the maximum credit. Employees must be certified with the appropriate state agency for businesses to claim the credit. Businesses claim the credit on their income tax return using Form 5884 and Form 3800. A separate claim procedure using Form 5884-C applies to eligible tax-exempt organizations.

Employee Health Care Coverage Credit

Small employers that pay at least half of the premiums for employee health insurance coverage under a qualifying arrangement may be eligible for the small business health care tax credit. The credit is designed to encourage small employers to offer health insurance coverage for the first time or maintain coverage they already have. Eligible small employers can claim the credit for 2010 through 2013 and for two additional years beginning in 2014. Targeted to small employers that primarily employ low- and moderate-income workers, the maximum credit, in tax-years 2010 through 2013, is 35 percent of premiums paid by small businesses and 25 percent of premiums paid by tax-exempt organizations, increasing to 50 percent and 35 percent, respectively, in 2014. Small businesses claim the credit on their income tax return using Form 8941 and Form 3800. Tax-exempt organizations also use Form 8941 and then claim the credit on Form 990-T.

Payroll Tax Relief

Many businesses can resolve worker classification issues at a low cost by voluntarily reclassifying their workers. By prospectively reclassifying workers, making a minimal payment and meeting a few other requirements, eligible businesses can achieve greater certainty for themselves, their workers and the government. Approval has been given to 540 employers to participate in the new IRS Voluntary Classification Settlement Program (VCSP) since it was launched in September 2011. The VCSP is available to many businesses, tax-exempt organizations and government entities that currently treat their workers or a class or group of workers as nonemployees or independent contractors, and that want to correctly treat these workers as employees in the future. To be eligible, an employer must:

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

Interested employers can apply for the program by filing Form 8952. Employers accepted into the program will pay an amount effectively equaling just over one percent of the wages paid to the reclassified workers for the past year. Moreover, employers will not be audited on payroll taxes related to these workers for prior years.

IR-2012-56, May 23, 2012

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