Slowdown in progress of tax legislation in Congress

As summer arrives in Washington, so does the usual slowdown in legislative activity and 2012 appears to be no exception.  Lawmakers have a full plate of tax-related bills on their agenda but progress is slow at best as both parties prepare for the November elections.  Among the pending tax bills are proposals to extend bonus depreciation, enact small business tax incentives, renew many expired extenders, and more.

Bonus depreciation.  In 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act provided for temporary 100 percent bonus depreciation.  Generally, 100 percent bonus depreciation was available for qualifying property placed in service after September 8, 2010 and before January 1, 2012 (or before January 1, 2013 in the case of property with a longer production period and certain noncommercial aircraft).

One hundred percent bonus depreciation is one of the few tax incentives on which Democrats and Republicans have found common ground.  President Obama has indicated his support for extending 100 percent bonus depreciation one additional year.  House Democrats introduced the Invest in America Now Act, which would extend 100 bonus depreciation through 2012 (through 2013 in the case of property with a longer production period and certain noncommercial aircraft).   The cost of repeal would be offset by denying the Code Sec. 199 domestic production activities deduction to oil and gas producers.

Reminder.  The 2010 Tax Relief Act also provided for 50 percent bonus depreciation for qualifying property placed in service before January 1, 2013 (or before January 1, 2014 in the case of property with a longer production period and certain noncommercial aircraft).

Small businesses.  Democrats and Republicans have unveiled competing small business tax bills.  The House approved a GOP-written bill, the Small Business Tax Cut Bill (HR 9).  Under the House bill, small businesses with fewer than 500 employees could claim a 20 percent deduction on qualified income in 2012. The deduction would be capped at 50 percent of qualified wages.

Meanwhile, Senate Democrats proposed their Small Business Jobs and Tax Relief Act of 2012 (Sen. 2237).  The bill would generally provide a 10 percent income tax credit on new payroll added by a qualified small employer in 2012. The credit would be capped at $500,000.  The Senate has not yet voted on the Democratic bill.

Tax incentives for small businesses have enjoyed bipartisan support in the past.  The GOP bill passed the House with Democratic support.  However, the GOP bill is not expected to be approved by the Senate if the bill comes up for a vote.

Bush-era tax cuts.  House Speaker John Boehner, R-Ohio, said in May that the House will vote on an extension of the Bush-era tax cuts before the November elections.  No legislation has been introduced and no vote scheduled.  It is unclear if House Republicans will propose extending the Bush-era tax cuts after 2012 without any offsets or if their bill will carry some revenue raisers.  House Republicans may also link an extension of the Bush-era tax cuts to spending cuts and budget reforms. The Budget Control Act of 2011 mandates across-the-board spending cuts in 2013 and beyond. In May, the House passed the Budget Sequestration Bill (HR 5652). The bill provides a substitute for the Budget Control Act.  The Senate is not expected to take up the Budget Sequestration Bill.

President Obama has reiterated his opposition to extending the Bush-era tax cuts for higher income taxpayers. The White House generally defines higher income taxpayers as individuals with incomes over $200,000 and families with incomes over $250,000.  Recently, some Democrats have spoken of higher thresholds, in the neighborhood of $1 million.  Lawmakers have also voiced the idea of a six-month or one-year extension of the Bush-era tax cuts.

Tax extenders.  It appears that lawmakers may not automatically renew all of the expired extenders as they have routinely done in past years.  In June, the chair of the Senate Finance Committee, Sen. Max Baucus, D-Montana, said that lawmakers should look at each extender and decide whether to eliminate it or make it permanent.  Baucus did not indicate which extenders should be made permanent and which should be jettisoned from the Tax Code. Among the likely candidates for being made permanent are the research tax credit, the higher education tuition deduction and the teachers’ classroom expense deduction.  All of these extenders have enjoyed bipartisan support.

Often included among the extenders is the so-called alternative minimum tax (AMT) patch.  The patch provides higher exemption amounts so the AMT does not encroach on middle income taxpayers.  The latest patch expired after 2011.  Proposals to extend the patch for 2012 have stalled, again over cost.  Lawmakers could leave the fate of the patch until after the 2012 elections.  However, late enactment of a patch would likely delay the start of the 2013 filing season because the IRS would need to reprogram its processing systems.

Pension funding.  Democrats and Republicans agree that the reduced interest rates on federal student loans should be extended one more year but disagree on how to pay for the estimated $6 billion cost of a one-year extension.  Changes to pension funding rules have been discussed as one way to pay for an extension of reduced federal student loan interest rates.

IRS budget.  The House and Senate are preparing for a showdown over the IRS’ fiscal year (2013) budget.  The House approved an $11.8 billion FY 2013 budget for the IRS budget.  The Senate is expected to approve a $12.5 billion FY 2013 budget.  Both amounts are, however, less than the funding levels requested by President Obama.  IRS Commissioner Douglas Shulman has warned Congress that reduced funding will negatively impact enforcement and customer service.  In FY 2012, Congress cut the IRS budget by $305 million and the agency responded by offering buyouts and early retirements to approximately 4,000 employees.

Transportation.  Agreement on a comprehensive transportation funding bill with tax offsets has eluded lawmakers.  The Senate passed the Moving Ahead for Progress in the 21st Century Act (MAP-21)(Sen. 1813). MAP-21 would provide parity among transit benefits, which had expired after 2011; allow Treasury to take a variety of measures against foreign financial institutions that engage in money laundering; and deny passports to individuals with seriously delinquent tax debt. House Republicans have a transportation bill but have not been able to pass it. Lawmakers are reportedly preparing another temporary extension of current funding.

Energy.  A number of energy tax incentives expired after 2011 and progress to renew them has stalled.  They include popular incentives for wind energy production and biomass fuels. President Obama proposed to repeal oil and gas tax preferences to pay for an extension of some of the energy incentives but lawmakers have shown little interest.

More proposals.  Many other tax bills are pending, including legislation to:

• Extend or make permanent the American Opportunity Tax Credit
• Repeal the excise tax on medical devices
• Revise health flexible spending arrangement rules for over-the-counter medications
• Extend the enhanced Work Opportunity Tax Credit for veterans
• Provide for tax rate parity among tobacco products
• Repeal the federal estate tax
• Enhance tax-exempt bonds
• And more

If you have any questions about pending tax legislation, please contact our office for more details (908) 725-4414.

Maximizing the benefits of dependency tax status not always straightforward

The dependency exemption is a valuable deduction that may be lost in many situations simply because some basic rules for qualification are not followed.  Classifying someone as a dependent can also entitle you to other significant deductions or credits.  Here is a rundown of some of the rules and their implications.

Exemptions reduce your adjusted gross income.  There are two types of exemptions: personal exemptions and exemptions for dependents.  For each exemption you can deduct $3,800 on your 2012 tax return.  In computing the amount to be withheld from an employee’s wages, the employee is entitled to an allowance equal to the exemption amount used to calculate the personal exemption deduction. On a joint return, you may claim one personal exemption for yourself and one for your spouse.  If you’re filing a separate return, you may claim the exemption for your spouse only if he or she had no gross income, is not filing a joint return, and was not the dependent of another taxpayer.

Exemptions for dependents.  You generally can take an exemption for each of your dependents.  A dependent is your qualifying child or qualifying relative. In some circumstances, even an aged parent who lives with you may qualify.  No personal exemption is allowed for a dependent or any other individual unless the taxpayer identification number (TIN) of that individual is included on the return claiming the exemption.  The TIN generally must be a social security number (SSN).

Support test.  A qualifying child must not have provided more than one-half of his or her own support during the calendar year in which the taxpayer’s tax year begins.  In contrast, the taxpayer must provide at least one-half of a qualifying relative’s support in order to claim the relative as a dependent.

As of the close of the calendar year in which the taxpayer’s tax year begins, a qualifying child must not have attained the age of 19, or must be a student who has not attained the age of 24.  This age test does not apply to a child who is permanently and totally disabled at any time during the calendar year in which the taxpayer’s tax year begins.  A student for this purpose is an individual who, during each of five calendar months of the calendar year in which the taxpayer’s tax year begins, is a full-time student at an educational organization, or is pursuing a full-time course of instructional on-farm training.  This five-month rules generally enables most parent of college students graduating in May to take their child as an exemption “one last time.”

An adoptive parent in the process of a domestic adoption who has custody of the child pending the final adoption and who provides enough financial support during the year is entitled to claim a dependency exemption for the child.

Possible downsides of being a dependent.  If someone else – such as your parent – claims you as a dependent, you may not claim your personal exemption on your own tax return.  Further, some people cannot be claimed as your dependent.  Generally, you may not claim a married person as a dependent if they file a joint return with their spouse.  Also, to claim someone as a dependent, that person must be a U.S. citizen, U.S. resident alien, U.S. national or resident of Canada or Mexico for some part of the year.  There is an exception to this rule for certain adopted children.

An individual who qualifies as another taxpayer’s dependent cannot claim any amount for a personal exemption, even if the individual files a return and the other taxpayer does not actually claim the individual as a dependent.  For instance, in a court case in which a college student filed his own return, he was not entitled to any deduction for his personal exemption because he also qualified as his parent’s dependent, even though they did not actually claim his exemption.

Ancillary benefits.  As discussed, a dependent cannot file joint returns or claim dependency exemptions.  In addition, a dependent who is a qualifying relative cannot have income in excess of the annual exemption amount.  However, these restrictions do not apply to a person’s classified as dependents for several other tax items.  If a person would qualify as a dependent but for filing a joint return, claiming dependency exemptions, or having gross income in excess of the exemption amount, the person is nonetheless treated as a dependent for the following purposes (not a complete list):

• the taxpayer’s head-of-household filing status;
• the exception from the early distribution penalty for qualified retirement plan distributions used to pay health insurance premiums for an unemployed taxpayer’s dependents;
• the exclusion from income of amounts received under accident and health insurance plans;
• the definition of a highly compensated participant for purposes of cafeteria plans;
• the exception from the rules that allow certain amounts paid to maintain a student in the taxpayer’s home to qualify as deductible charitable contributions;
• the deduction for medical expenses incurred by the taxpayer’s dependent;
• the exclusion for distributions from an Archer medical savings account (MSA) that are used to pay a dependent’s medical expenses;
• the rules governing the deduction for qualified student loan interest; and the treatment of educational and medical indebtedness in calculating the value of a decedent’s qualified family-owned business interests for purposes of the estate tax.

As you may gather, the rules associated with the dependency exemption can get complex rather quickly.  If you need any assistance in sorting out any dependency exemption or related benefits, please you do hesitate to contact this office at (908) 725 4414.

FAQ…Has IRS Fresh Start penalty relief expired?

Yes, penalty relief under the IRS Fresh Start initiative was a one-time offer, which required individuals to file Form 1127-A, Application for Extension of Time for Payment of Income Tax for 2011 Due to Undue Hardship, by April 17, 2012.

Penalties

The Tax Code imposes penalties on individuals who fail to file a return when one is required to be filed and on individuals who fail to pay any tax by the due date.  Often, taxpayers find that penalties can be more onerous than the taxes actually owed.

The penalty for filing a return late is generally five percent of the unpaid taxes for each month or part of a month that a return is late. The IRS has explained that this penalty will not exceed 25 percent of your unpaid taxes. Individuals who fail to pay their taxes by the due date, generally are liable for a failure-to-pay penalty of one-half of one percent of the unpaid taxes for each month or part of a month after the due date that the taxes are not paid. The IRS has cautioned that the penalty can be as much as 25 percent of the unpaid taxes.

If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the failure-to-file penalty is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.

Generally, the period of delinquency runs from the day after the due date of the return until the return is actually received by the IRS. In determining the number of months for which the penalty is imposed, the due date of the return determines when months begin and end. Individual returns for 2011 were due April 17, 2012.

Fresh Start relief

In early 2012, the IRS announced special penalty relief for individuals who found themselves unable to pay their taxes by the April 17 due date.  This relief was part of the IRS’ “Fresh Start” initiative.

Penalty relief was available to two groups:

• Wage earners who had been unemployed at least 30 consecutive days during 2011 or in 2012 up to the April 17, 2012 deadline for filing a federal tax return this year.

 

• Self-employed individuals who experienced a 25 percent or greater reduction in business income in 2011 due to the economy.

The taxpayer also had to have adjusted gross income of less than $100,000 (or $200,000 for a married couple filing a joint return). Additionally, the amount owed to the IRS had to be less than $50,000.

Under the Fresh Start initiative, interest runs on the 2011 taxes until the tax is paid.  However, no failure-to-pay penalties will be incurred if tax, interest and any other penalties are paid in full by October 15, 2012.

Deadline passed

The IRS required taxpayers to file Form 1127-A to request penalty relief by April 17, 2012.  At this time, it appears that the IRS is not bending this rule. However, the IRS could adjust its approach.  If the IRS announces any changes, our office will keep you posted.

Landmark health care decision; now what?

On June 28, the U.S. Supreme Court issued its long-awaited landmark decision on the Patient Protection and Affordable Care Act (PPACA) and its companion law, the Health Care and Education Reconciliation Act (HCERA). In a 5 to 4 decision of historic proportions, the nation’s highest court upheld the law – except for a certain Medicaid provision involving state funding.  Key to the Court’s approval of President Obama’s signature health care law was the finding that the linchpin individual mandate was constitutional.  The requirement under the individual mandate that individuals pay a penalty if they fail to carry minimum essential health insurance coverage was declared within the Constitution based upon Congress’s power to tax.

The Supreme Court’s decision preserves all of the far-reaching tax provisions and health insurance reforms that were part of the overall health care reform legislation as passed in 2010. In coming months, lawmakers and legal scholars will examine all of the nuances of the Court’s highly complex decision.  More immediately, individuals and businesses are concerned about what steps they need to take next.

Role of taxes

To a large extent, the Obama administration’s health care law is driven by tax provisions, to provide the carrot, the stick and adequate funding in alternating quantities. The role played by taxes in the new health care provisions is also underscored by the predominate part that the IRS will play in its administration.

Under the health care law, a number of tax provisions are scheduled to take effect in 2013 and beyond. The court’s decision allows the numerous tax provisions within the health care laws to move forward on schedule. Some important provisions have already taken effect; others will take effect in 2013 and 2014. One provision, the excise tax on high-cost employer-sponsored coverage, will not take effect until 2018.

Main provisions/effective dates

PPACA and HCERA include the following tax provisions (not a complete list):

• Small employer Sec. 45R credit, effective for tax years beginning in 2010 – the government will provide a credit of 35 percent of health insurance premiums to small employers (25 percent for tax-exempt organizations. The credit expires after 2015.
• Economic substance doctrine, effective after March 30, 2010 – the economic substance test was codified as a two-prong test, requiring that the transaction change the taxpayer’s economic position in a meaningful way, and that the taxpayer has a substantial business purpose for the transaction.
• Over-the-counter limitations for health accounts, effective for tax years beginning after December 31, 2010 – health accounts, such as flexible spending arrangements, health reimbursement arrangements, health savings accounts, and Archer Medical Savings Accounts, can only reimburse expenses for medicine and drugs if the item is a prescription drug (or insulin).
• Indoor tanning services excise tax, effective on or after July 1, 2010 – amounts paid for indoor tanning services are subject to a 10-percent excise tax. Tanning salons must collect the tax and pay it quarterly.
• Itemized deduction for medical expenses, effective for tax years beginning after December 31, 2012 – the threshold for deducting medical expenses as an itemized deduction is raised from 7.5 percent to 10 percent of adjusted gross income.
• Additional 0.9% Medicare tax, effective after December 31, 2012 – an additional 0.9 percent Medicare tax is imposed on wages and self-employment income of higher-income individuals: individuals – above $200,000; married filing jointly – above $250,000; married filing separately – above $125,000.
• 3.8% Medicare contribution tax, effective after December 31, 2012 – a 3.8 percent Medicare tax is imposed on unearned income for higher-income individuals, including interest, dividends, annuities, royalties, rents and other passive income.
• Medical device excise tax, effective for sales after December 31, 2012 – a 2.3 percent excise tax is imposed on sales of certain medical devices by manufacturers, producers and importers. Retail items such as eyeglasses are excluded from the tax.
• Employer shared responsibility, effective after December 31, 2013 – the “employer mandate”: an applicable large employer (50 or more full-time employees) must make a payment if any full-time employee can receive the premium tax credit. The payment is required if the employer does not offer minimum essential coverage, or offers coverage that is not affordable.
• Branded prescription drug fees, effective for calendar years beginning after December 31, 2010 – an annual fee imposed on manufacturers and importers with receipts from branded prescription drug sales.
• Sec. 36B premium assistance credit, effective for tax years ending after December 31, 2013 – lower-income individuals who obtain health insurance coverage through an insurance exchange may qualify for the credit, unless they are eligible for other minimum essential coverage.
• Excise tax on high-dollar insurance, effective for tax years beginning after December 31, 2017 – employer-sponsored health coverage whose cost exceeds a threshold amount ($10,200 for self-on coverage; $27,500 for other coverage) will be subject to a 40-percent excise tax.

Looking ahead

Employers, taxpayers – indeed everyone – must prepare for sweeping changes in health care in coming years.  Many of the provisions in the PPACA have already been implemented or are in the process of being implemented.  Other provisions, as the above list indicated, are scheduled to take effect after 2012.  The Supreme Court’s upholding of the PPACA clears the way for full implementation of the new law (unless a future Congress votes to repeal the law, which at this point would be an uphill battle). Our office will keep you posted of developments and the steps you need to take in the coming months.

How do I….Make matching contributions to a SIMPLE IRA plan?

A SIMPLE (Savings Incentive Match Plan for Employees of Small Employers) IRA is a retirement savings plan designed specifically for small employers. A SIMPLE IRA is an IRA-based plan with ease of use features intended to encourage small employers, which may otherwise not offer a retirement plan, to create a retirement plan.

Basics

Generally, any business with 100 or fewer employees can establish a SIMPLE IRA. If an employer establishes a SIMPLE IRA plan, all employees of the employer who received at least $5,000 in compensation from the employer during any two preceding calendar years (whether or not consecutive) and who are reasonably expected to receive at least $5,000 in compensation during the calendar year, must be eligible to participate in the SIMPLE IRA.  For purposes of the 100-employee limitation, all employees employed at any time during the calendar year are taken into account

SIMPLE IRAs must be established under a written plan agreement.  All employees must be notified about the SIMPLE IRA plan. Generally, employees must be informed about his or her opportunity to make or change a salary reduction choice under the SIMPLE IRA plan and the employer’s decision to make either matching contributions or nonelective contributions.  Employees are always 100 percent vested in a SIMPLE IRA.

Salary reduction contributions

SIMPLE IRAs are subject to important limits on salary reduction contributions.  The limit is $11,500 for 2012.  However, employees age 50 or over may make so-called $2,500 “catch-up” contributions for 2012.

Employer contributions

Employers have two choices in determining their contributions to a SIMPLE IRA plan:

• A two percent nonelective employer contribution, where employees eligible to participate receive an employer contribution equal to two percent of their compensation (limited to $245,000 per year for 2012 and subject to cost-of-living adjustments for later years), regardless of whether the employee makes his or her own contributions.
• A dollar-for-dollar match, up to three percent of compensation, where only the participating employees who have elected to make contributions will receive an employer contribution (this is called a matching contribution).

Each year, employers can choose which one they will use for the next year’s contributions. This choice must be communicated to employees.  Owners of small businesses can use SIMPLE IRA plans as vehicles for retirement savings for themselves without reference to how many of their employees actually participate, as long as the employees are given the option.

The three percent matching contribution applies if the employee has made a contribution.  In contrast, the two percent nonelective contribution applies even if the eligible employee did not make a contribution.

Let’s look at an example:  Jacob, age 29, has worked for his employer for five years. This year, the employer established a SIMPLE IRA plan for Jacob and its other 44 employees. The employer will match contributions made by Jacob and the other employees dollar-for-dollar up to three percent of each employee’s compensation. Jacob contributes three percent of his yearly compensation to his SIMPLE IRA (three percent of $40,000 or $1,200).  His employer’s matching contribution is also $1,200.  The total contribution to Jacob’s SIMPLE IRA is $2,400.

The three percent limit on matching contributions may be reduced for a calendar year at the election of the employer, but only if the limit is not reduced below one percent; the limit is not reduced for more than two years out of the five-year period that ends with (and includes) the year for which the election is effective; and employees are notified of the reduced limit within a reasonable period of time before the 60-day election period during which employees can enter into salary reduction agreements. If an employer fails to satisfy the contribution rules, the SIMPLE IRA plan is in jeopardy of losing its tax benefits for the employer and all participants.

If you have any questions about matching contributions to SIMPLE plans or how to set up a SIMPLE plan, please contact our office at (908) 725-4414.