Vernoia, Enterline + Brewer, CPA LLC

Archive for June, 2012

No resolution to Bush-era tax cuts and more…

Hopes for a pre-election resolution to the fate of the Bush-era tax cuts, extenders and other tax incentives are quickly fading as summer approaches.  This year is increasingly looking like a replay of 2010, the last time the Bush-era tax cuts were facing imminent expiration.  The White House, the Democratic-controlled Senate and the GOP-controlled House all have different opinions on the fate of these tax incentives and negotiations, which have been few and far between, and have quickly bogged down.  One solution, which is being talked about more and more, is a temporary extension of the tax cuts.  While this would punt the issue to the next Congress, it does little to ease taxpayers’ concerns about tax planning in a climate of constant uncertainty.

Bush-era tax cuts

Unless extended, the tax cuts in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) (as extended by the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010) will sunset after December 31, 2012.  The list of expiring tax incentives is long and includes reduced individual income tax rates and capital gains/dividends tax rates; the $1,000 child tax credit; enhancements to the earned income tax credit (EIC); and much more.

On May 15, House Speaker John Boehner, R-Ohio, said that the House will vote before the November elections on legislation to extend the Bush-era tax cuts.  Boehner gave no timetable for a vote.  It is unclear at this time if the GOP plans to vote on making the Bush-era tax cuts permanent or merely to extend them one or two more years. Also unclear is whether or not any extension would be offset with revenue raisers elsewhere.  Even if the House votes on the tax cuts, there is no guarantee the Senate will take them up.

Complicating matters is the federal budget deficit.  After months of partisan wrangling last year, Congress passed the Budget Control Act of 2011 (BCA).  The BCA imposes mandatory, across-the-board spending cuts through sequestration.  The BCA’s spending cuts are scheduled to take effect in 2013.  The GOP wants to repeal the BCA and on May 10, the House approved legislation to effectively do that.  The GOP bill has no chance of passage in the Democratic-controlled Senate.  So the BCA remains, for now, law.

Few Capitol Hill observers expect Congress to take any meaningful action on the Bush-era tax cuts before the November elections. This leaves the fate of the Bush-era tax cuts to the lame duck Congress.  Depending on the outcome of the November elections, the lame duck Congress could do nothing and allow the Bush-era tax cuts to expire, make the tax cuts permanent, or – and this appears to be the most likely scenario – extend the tax cuts for one year. Either way, the uncertainty complicates tax planning for 2012 and beyond.

Small businesses

Lawmakers are also dueling over competing small business tax bills. The House has approved the GOP-sponsored Small Business Tax Cut Act.  The GOP bill would, among other provisions, provide a deduction for 20 percent of qualified domestic business income of the taxpayer for the tax year, subject to limitations. In the Senate, the Democrats’ small business bill would give a 10 percent income tax credit to small employers that increase wages or create jobs in 2012 and extend 100 percent bonus depreciation through 2012 (which had expired at the end of 2011).   If the Senate approves the Democratic bill, the two chambers could iron-out the differences in the bills in conference.

Tax extenders

Since January, supporters of the tax extenders have tried several times, all unsuccessfully, to attach the extenders to other bills.  Some of the extenders were initially attached to the Middle Class Tax Relief and Job Creation Act of 2012, which extended the employee-side payroll tax cut for all of calendar year 2012, but were subsequently dropped. Supporters also tried to include many of the extenders, especially energy-related tax incentives, to the Senate’s highway funding bill: the Moving Ahead for Progress in the 21st Century (MAP-21) Act.  At the last minute, the extenders were removed from the Senate bill.

A drag on the extenders is their estimated cost to the federal budget.  According to the Congressional Research Service, renewing all of the extenders for 2012 would cost $35 billion. This is one reason why supporters have tried to move only some of the extenders.  There have also been calls in Congress to let some of the extenders expire permanently; but every extender has its supporter.

Federal estate tax

Another big question mark hovers over the federal estate tax.  Unless Congress acts, the federal estate tax is schedule to revert to its pre-EGTRRA levels (a top tax rate of 55 percent with a $1 million exclusion).  In 2010, the White House and the GOP agreed on a top tax rate of 35 percent with a $5 million exclusion (indexed for inflation) for decedents dying in 2011 and 2012 (special rules applied to decedents dying in 2010).  The GOP has proposed to eliminate the estate tax entirely or, if not abolished, to retain the 35/$5 million amounts for decedents dying after 2012; the White House has proposed to reduce the exclusion amount to $3.5 million.

Our office will monitor developments and keep you posted of any changes. If you have any questions about legislative developments, please contact our office at (908) 725-4414.

Education tax incentives planning

Education tax incentives are often underutilized because the rules are so complex. Some of the incentives are tax credits; other deductions. There are also savings plans for education costs. Making things even more complicated is the on-again, off-again nature of the education tax incentives.  Under current law (as of June 2012), several taxpayer-friendly features of the incentives are scheduled to expire.

American Opportunity Tax Credit

The American Opportunity Tax Credit (AOTC) is an enhanced version of the old Hope credit. The AOTC offers eligible taxpayers a credit of 100 percent of the first $2,000 of qualified tuition and related expenses and 25 percent of the next $2,000.  That means the credit reaches a maximum of $2,500.

Four years. The AOTC can be claimed for the first four years of a student’s post-secondary education (including college and university, vocational school and other qualified institutions of learning).

The full AOTC is available to individuals whose modified adjusted gross income is $80,000 or less ($160,000 or less for married couples filing a joint return). If your modified adjusted gross income is above that amount, the credit begins to phase out.  Eligible individuals may receive a refund of 40 percent of the AOTC.

Sunset.  The AOTC is scheduled to expire after 2012.  At that time, the old Hope credit will return.

Lifetime Learning Credit

The Lifetime Learning Credit is often in the shadow of the AOTC.  One reason may be that the Lifetime Learning Credit and the AOTC cannot be claimed in the same year. The Lifetime Learning Credit reaches $2,000 for qualified educational expenses.

Key difference. There is one very valuable difference between the Lifetime Learning Credit and the AOTC. There is no limit on the number of years the Lifetime Learning Credit can be claimed.  This requires careful planning.  Individuals who are considering graduate school may want to use the AOTC for undergraduate expenses and the Lifetime Learning credit for graduate school expenses.

No sunset.  The Lifetime Learning Credit is not scheduled to expire after 2012.  It is one of the few tax incentives that have essentially remained unchanged in recent years.

Student Loan Interest Deduction

Individuals who took out loans to finance their post-secondary education may qualify for a deduction. Student loan interest is interest you paid during the year on a qualified student loan. The loan proceeds must have been used for qualified higher education expenses, including tuition and room and board.

Above-the-line. The student loan interest deduction (and the expired higher education deduction discussed below) is an above-the-line deduction. This means you can claim the deduction even if you do not itemize deductions.

Sunsetting features. Under current law, there is no limitation as to the number of months during which interest paid on a student loan is deductible.  After December 31, 2012, a 60-month limitation is scheduled to return. The student loan interest deduction is subject to income limits.  Under current law, the   deduction is reduced when modified adjusted gross income exceeds $60,000 for single individuals ($125,000 for married couples filing a joint return) and is completely eliminated when modified adjusted gross income is $75,000 or more for single individuals ($155,000 for married couples filing a joint return). After December 31, 2012, these income limitations are scheduled to be significantly lower.

Coverdell Education Savings Accounts

Coverdell Education Savings Accounts (ESAs) are similar to IRAs. Contributions are not tax-deductible but the funds grow tax-free until distributed. Distributions are tax-free if they are used for qualified education expenses of the beneficiary.

Not just post-secondary.  Under current law, funds in a Coverdell ESA can be used for elementary and secondary school expenses as well as post-secondary education costs.  Coverdell ESAs are the only education tax incentive to offer this feature.  The AOTC, Lifetime Learning Credits and 529 plans (discussed below) are limited to post-secondary education.  However, this special feature of Coverdell ESAs is scheduled to expire after 2012.  At that time, Coverdell ESA dollars will only be available for post-secondary expenses.

Contribution limitation.  Total contributions to a Coverdell ESA cannot be more than $2,000 in any year for the beneficiary. This rule applies no matter how many Coverdell ESAs are established. However, the $2,000 amount is scheduled to fall to $500 after 2012. Income limitations also apply. If you use the funds in a Coverdell ESA for a non-qualified purpose, there is a 10 percent additional tax.

529 Plans

States and institutions of higher learning can create so-called “529 plans.” Funds in a 529 plan can be used for qualified post-secondary expenses, such as tuition and room and board, of the designated beneficiary.  Contributions are not tax-deductible but distributions are tax-free, so long as they pay qualified expenses. There are many 529 plans. Before selecting one, please contact our office.  We can help you select the 529 plan that meets your expectations.

No income limitations. 529 plans are similar to Coverdell ESAs with one very important difference. There are no income limitations for contributors.

Higher education deduction

Finally, there is the higher education deduction.  This popular deduction allows eligible individuals to claim a deduction for certain higher education costs.  The higher education tuition deduction reaches $4,000.  That’s the good news….the bad news is that the deduction expired after 2011.

May be renewed.  There have been several attempts in Congress to renew the deduction for 2012 but they have failed to pass.  Congress could renew the deduction late in 2012 or early in 2013 and make the deduction retroactive to January 1, 2012.

Like other education incentives, the higher education deduction had some restrictions.  One of the most important is income.  An individual’s modified adjusted gross income could not exceed $80,000 ($160,000 if married filing a joint return).

We have covered a lot of ground discussing these education tax incentives.  Please contact our office at (908) 725-4414 for more details and to discuss how we can create a plan using some or all of these incentives that delivers the most value.

FAQ: What is a “real-time” tax system?

IRS Commissioner Douglas Shulman unveiled his “real-time” tax system idea late in 2011. Since then, the IRS has had public meetings with stakeholders, including representatives of taxpayers, government officials, tax professional associations, and many others, to discuss moving the IRS away from its traditional “look-back” system to a “real-time” system. As explained by Shulman, the goal of a real-time system is to resolve problems with a taxpayer’s return before it is processed rather than wait until after it is processed.

Real-time system

Today, many routine transactions, especially financial transactions, are done in “real-time.”  Consumers can access their bank and other financial accounts online 24/7.  Communicating and doing business with the IRS, however, is still very much slower.

Traditionally, the IRS has operated on a “look-back” system. That is, the IRS accepts returns, processes them and then contacts taxpayers about any problems on the returns. Frequently, it takes the IRS many months to contact a taxpayer about an issue with a return. A real-time tax system, as described by Shulman, would improve the return filing process by accelerating the IRS’s response time.

Under a real-time tax system, the IRS would match information submitted on a return with third-party information at the beginning of processing rather than after the return has been processed.  This “real-time” activity would give taxpayers the opportunity to correct their return before the IRS completes processing the return. Problems could be resolved much more quickly, Shulman has predicted.

Forms W-2

A real-time tax system could begin with changes to the processing of Form W-2, Wage and Tax Statement.  Requiring more electronic filing of Forms W-2 by employers could improve processing time, payroll industry representatives told the IRS in January 2012. However, a real-time tax system would likely require the IRS to accelerate the matching of Form W-2 data it receives from the Social Security Administration (SSA) and that could place an additional burden on the SSA.

Issues

Moving to a real-time tax system is not something that will happen overnight.  Proponents of a real-time tax system have recommended moving up the April 15 filing date. Under current law, the deadline for filing individual income tax returns is April 15 and only Congress can change that date.

The IRS would also have to adjust its return processes. The IRS currently resolves most mismatches of return information and third-party information post-filing. Resolving these issues before a return is processed would likely require more IRS personnel and would also impact many professional return preparers during their busiest time of the year: the filing season.

The IRS is currently operating under very tight budget parameters. Congress reduced the IRS’s funding for fiscal year (FY) 2012 and additional cuts may be made in future IRS budgets. These budgetary pressures make moving to a real-time tax system unlikely at the present. Most recently, Shulman acknowledged that a real-time tax system is a “long-term destination” rather than a “short-term project.”

If you have any questions about the IRS’s real-time proposal, please contact our office at (908) 725-4414.

“FBAR” deadline on foreign accounts

A U.S. person with financial interests in or signature authority over foreign financial accounts generally must file Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) if, at any point during the calendar year, the aggregate value of the accounts exceeds $10,000. The FBAR form is due by June 30 of the calendar year following the calendar year being reported. Thus, FBARs for 2011 are due by June 30, 2012. An FBAR is not considered filed until it is received by the Treasury Department in Detroit, MI.

Aggregate value.  To determine whether a U.S. person has interests in or authority over foreign accounts with an aggregate value of at least $10,000 during the year, the maximum values of all of the accounts are added together. An account’s maximum value is a reasonable approximation of the greatest value of currency or nonmonetary assets in the account during the year.  Account value is determined in the currency of the account.

Signatures. An FBAR filed by an individual must be signed by the filer identified in Part I. The filer’s title should be provided only if the FBAR reports signature authority over a foreign account. In that case, the title should be the one on which the individual’s signature authority is based.
An FBAR filed by an entity must be signed by an authorized individual, whose title must also be provided. If spouses file only one FBAR to report their jointly owned accounts, they must both sign the FBAR.

Jointly owned accounts.  Generally, when one account has more than one owner, each owner that is required to file an FBAR must report the entire maximum value of the account. Each owner must also provide the number of other owners of each account. The FBAR should use the identifying information for the principal owner.  Simpler rules apply when joint owners are also spouses. If one spouse files an FBAR the other spouse is not required to file a separate FBAR if: (1) all of the nonfiling spouse’s foreign financial accounts are jointly owned with the filing spouse; (2) the filing spouse reports all of those jointly-owned accounts on a timely filed FBAR; and (3) both spouses sign the FBAR.

Where to file.  The FBAR is not filed with the taxpayer’s federal income tax return. Instead, it is filed with the Treasury Department (although the IRS accepts hand deliveries for forwarding).

There are four methods for filing an FBAR. (1) Mail the FBAR to: Department of the Treasury, PO Box 32621, Detroit MI 48232-0621; (2) Send the FBAR via an express delivery service to: IRS Enterprise Computing Center, ATTN: CTR Operations Mailroom, 4th Floor
985 Michigan Ave., Detroit MI 48226; (3) Hand deliver the FBAR to any local IRS office (including IRS attaches located in U.S. embassies and consulates) for forwarding to the Treasury, Detroit MI; or (4) File the FBAR electronically. E-filers must first apply to become a BSA (Bank Secrecy Act) e-filer.

Record-keeping.  Persons who must file FBARs must also retain records that show: the name in which each account in maintained, the account number or other designation, the name and address of the foreign financial institution that maintains the account, the type of account, and each account’s maximum account value during the reporting period.

These records must be kept for five years following the FBAR’s due date. The records must also be available for inspection by the Treasury Department.

FATCA.  Keep in mind that you may also be required to file new IRS Form 8938, Statement of Specified Foreign Financial Accounts. The Foreign Account Tax Compliance Act (FATCA) of 2010 created separate and distinct reporting requirements for certain taxpayers holding specified foreign financial assets. New Form 8938, Statement of Specified Foreign Financial Assets, is similar to the FBAR but has some important differences.

The threshold for filing Form 8938 is higher than the FBAR (and the threshold varies depending on the taxpayer’s status and location). Form 8938 also applies – at this time – to only specified individuals and covers only specified foreign financial assets. Unlike the FBAR form, Form 8938 is filed together with your Form 1040 tax return if required.

Please call our office at (908) 725-4414 if you are not sure whether you must file an FBAR Form or you are unsure about what information to report.  While the Treasury has waived some penalties in the past when FBAR reporting was new, it has indicated that it will be less forgiving, if at all, for FBAR Forms required by the June 30, 2012 deadline.