Vernoia, Enterline + Brewer, CPA LLC

Archive for September, 2012

Federal Student Aid (FAFSA) IRS Data Retrieval Tool

The IRS has unveiled the IRS Data Retrieval Tool (DTR), a time-saving tool designed to minimize the time required for college-bound students and their parents to complete the Department of Education’s Free Application for Federal Student Aid (FAFSA). The new IRS DTR is available through the website www.fafsa.gov.

The FAFSA form is necessary for college-bound students and their parents who are applying for numerous federal government education programs or subsidies, such as the Pell Grant, low-interest federal student loans, and the Federal Work Study Program. Eligible taxpayers may use the tool for either the initial or the renewal FAFSA.

Completion of the FAFSA requires certain federal tax information such as the student and parents’ adjusted gross income, tax, and exemptions. The free IRS DTR tool enables applicants to automatically transfer their tax return information onto the FAFSA form. The tool will also increase the accuracy of the income information reported on the FAFSA form and minimize processing delays. Taxpayers who are eligible to use the DRT can access it one to two weeks after the federal income tax return is filed if the return is filed electronically. In the cases of a paper tax return, taxpayers may access the tool approximately six to eight weeks after filing.

Who can use the DRT?

To use the DRT to complete the 2012–2013 FAFSA, taxpayers must meet several prerequisites:

  1. They must have filed a federal 2011 tax return;
  2. Have a valid SSN;
  3. Have a valid Federal Student Aid PIN; and
  4. Have not changed marital status since December 31, 2011.

What if I don’t have a PIN?

If an individual does not have a Federal Student Aid PIN, he or she may apply for one beforehand through the FAFSA application process. An online application is available at www.pin.ed.gov.

What if I can’t use the DRT?

In some cases the IRS DRT is unavailable. The tool is not accessible for completion of the 2012-2013 FAFSA if either the student or parents:

  1. Filed an amended 2011 tax return or did not file a 2011 tax return;
  2. Filed their 2011 tax return as married, filing separately; or
  3. Filed a foreign tax return or Puerto Rican tax return.

If a student cannot or chooses not to use the IRS DRT, that student, his or her parents or spouse can verify income information submitted to the Financial Aid Office through a tax transcript from the IRS. Applicants may request a transcript on IRS Form 4506-T, Request for Transcript of Tax Return. Transcripts may be requested online through www.irs.gov or by phone at 1-800-908-9946.

Deduction claims for storm or drought damage

When disaster strikes, a casualty tax loss may provide some comfort. A casualty is the damage or destruction of property resulting from an identifiable event that is sudden, unexpected, or unusual. Damage resulting from the progressive deterioration of property through a steadily operating cause would not be a casualty loss. A deductible loss can result from a number of events, such as fire, flood, storm (including hurricanes and tornadoes), or earthquake. Storm losses can involve damage from flooding or wind, for example. Other “sudden and unexpected events,” such as an automobile accident, also qualify as a casualty for tax purposes.

According to the most recent reading of the U.S. Drought Monitor and other indicators, moderate to exceptional drought covered approximately 60 percent of the contiguous U.S. as of the end of August and is being compared to the droughts of the 1930’s, 1950’s and the summer of 1988. Unless a loss attributable to drought occurs in a trade or business or a for-profit transaction, however, it is generally not deductible. A loss must occur within a short period of time, for it to be deductible as a casualty loss. The IRS has said that most droughts lack the suddenness necessary for a casualty loss deduction. The conventional tax wisdom has been that, as a practical matter, a casualty loss should not be claimed unless there has been an officially declared water emergency or some general drought designation by the IRS. For example, a casualty loss deduction was allowed for structural damage to a house because of subsoil shrinkage in a 1977 Missouri drought that was declared a federal disaster. So far, the IRS has not spoken to the drought of 2012 but some guidance is expected to be announced in the near future.

Taxpayer has burden of proof

To deduct a casualty loss, the taxpayer must be able to show that there was a casualty loss and to justify the amount taken as a deduction. A taxpayer should be able to show: the type of casualty and its date of occurrence; that the loss was a direct result of the casualty; that the taxpayer owned the property (or was liable for the damage to the owner of the property); and whether there is a claim for reimbursement with a reasonable expectation of recovery.

Business property

The allowable deduction for business property destroyed in a casualty is usually different from the loss of personal property. If the property is used in a trade or business or other activity conducted for profit, the allowable deduction is the lesser of the property’s adjusted basis (before the casualty) or its decline in value because of the casualty. If business property is completely destroyed, the deduction is the full amount of the property’s adjusted basis, reduced by any insurance recovery, even if the basis exceeded the property’s value before the casualty.

Personal-use property

If property owned outside of the business or investment setting, like a personal residence, is damaged, the loss is the lesser of the property’s decline in value or its adjusted basis, reduced by insurance proceeds or other reimbursement. Unlike business property, if personal property is completely destroyed, the loss cannot exceed the decline in value from the casualty, even if this is less than the basis. Furthermore, the loss must be reduced by $100 per casualty, and is deductible only to the extent that net casualty and theft losses exceed 10 percent of the taxpayer’s adjusted gross income. Unlike businesses, however, individuals have the option of treating a casualty loss as occurring in the immediately prior year, thereby often allowing for a quick refund through filing an amended return.

“Timely” insurance claim

To deduct a personal casualty loss, the taxpayer must have filed a timely insurance claim. The loss may be disallowed if the taxpayer fails to file a claim. Any portion of the loss that is not covered by insurance is not subject to this rule.

A recent court case discusses the requirement to file a timely insurance claim. A homeowner suffered loss of his home from fire. The homeowner immediately notified his insurance company of the loss, was assigned a claim number, and had the insurance company inspect the damage. However, the insurance company denied the claim. One reason it gave was that the homeowner failed to provide a statement as to proof of loss within 60 days, as required under the policy. After the insurance company denied the claim, the homeowner took a casualty loss deduction on his amended tax return.

Taxpayer deduction upheld

The IRS denied the casualty loss deduction, claiming that the taxpayer had failed to file a “timely insurance claim” as required by the tax code. The Federal Court of Claims rejected the IRS’s action and allowed the claim. The court said it was clear that the homeowner had filed a claim with the insurance company and that this was sufficient to comply with the tax code. The company’s ultimate denial of the claim under the terms of the policy was not relevant.

If you have suffered a casualty, it is important that you claim the full amount of the tax deduction to which you are entitled. If you have any questions about casualty losses, please contact our office at (908) 725-4414.

Questions remain about “repair” regulations

More than six months after the IRS issued temporary “repair” regulations (T.D. 9564), many complex questions remain about their interpretation and application. These regulations are sweeping in their impact. They have been called game-changers for good reason, affecting all businesses in one way or another and carrying with them both mandatory and optional requirements. Many of these requirements also carry fairly short deadlines.

The new regulations are generally effective for tax years beginning on or after January 1, 2012. However, certain portions are effective for amounts paid or incurred in tax years beginning on or after January 2, 2012, a subtle but important difference. To complicate matters further, the regulations are, in effect, retroactive insofar as accounting method changes are needed to be filed with the IRS in many cases and adjustments made to reflect these changes.

The new regulations are called “temporary” only because the IRS reserves the right to fine-tune them and issue “final” regulations – the IRS may do this before year end, but it has a three year deadline to do so. In the meantime, the “temporary” regulations stand in as the law.

Highlights

The new regulations present both compliance challenges and planning opportunities. The major take away from examining these new regulations is that it is to the advantage of virtually all businesses to reconsider how they treat certain repairs and improvements for tax purposes.

The following highlights cover only some of the many changes made by the new repair regulations:

Materials and supplies. The definition of materials and supplies has been revised along with the rules for determining the proper tax year for a deduction. The new regulations allow an election to capitalize materials and supplies, and contain special rules for rotable spare parts.

De minimis expensing. Taxpayers with an “applicable financial statement,” such as a certified audited financial statement, may now claim a current deduction for the cost of acquiring items of relatively low-cost property, including materials and supplies, if specific requirements are met. Under the general rule, materials and supplies are usually deducted in the tax year used or consumed. The new election to deduct materials and supplies under the de minimis rule is particularly helpful if the tax year in which the cost of the materials and supplies is paid or incurred occurs before the tax year of use or consumption.

Amounts paid to acquire or produce tangible property. This portion of the regulations explains which costs associated with the acquisition or production of real or personal property must be capitalized to the basis of the property and which costs may be claimed as a current deduction.

Amounts paid to improve tangible property. This is the heart of the new regulations which provides rules for distinguishing repairs from capital expenditures. It divides capital expenditures into three categories of improvements: betterments, restorations, and adaptations. Generally, whether an expenditure is an improvement is based on facts and circumstances. A safe harbor rule is provided for routine maintenance activities. Also, certain regulated taxpayers may elect to use their regulatory accounting method to distinguish between repairs and capital expenditures.

Unit of property defined. The “unit of property” is a critical concept in determining whether an expenditure is a repair or capital expenditure. Generally, the larger the unit of property, the more likely that work on that property will be considered a deductible repair. The regulation contains detailed rules for determining the size of a unit of property in the case of buildings and other types of property. Planning opportunities present themselves within this framework.

MACRS general asset accounts. MACRS stands for modified accelerated cost recovery system, which is the basis system now used for the tax depreciation of most assets. Importantly, an election to recognize gain or loss by reference to the adjusted basis of an asset disposed of from a GAA now applies to virtually any asset disposed of. Previously, a taxpayer was usually required to recognize the entire amount realized upon a disposition as ordinary income, and no loss deduction was allowed. Bottom line: A taxpayer may now place an asset, such as a building, in a GAA and—whenever an asset, such as a structural component, is retired—choose whether to follow the GAA default rule that no loss is recognized or elect to recognize a loss equal to the adjusted depreciable basis of the asset.

Businesses that previously retired a structural component which is currently still being depreciated will need to change accounting methods to bring the treatment of the structural component into compliance with the new rules. For most taxpayers, the change in method will involve making a retroactive MACRS general asset account election and then deciding whether to claim a loss on the retired component through a so-called 481(a) adjustment or to continue to depreciate the retired component.

12.8 million get Medical Loss Ratio rebates

Is your Medical Loss Ratio (MLR) rebate check taxable? The U.S. Department of Health and Human Services (HHS) estimates that nearly 12.8 million Americans received more than $1.1 billion in MLR rebates during August 2012 based on insurance company shortfalls in cutting overhead during 2011. If you received a rebate, either as an individual policyholder or as an employer or employee, is it taxable?

The first round of annual MLR rebates payable under the Patient Protection and Affordable Care Act (PPACA) (aka ObamaCare) were required to be disbursed to health insurance policyholders by insurance companies on or before August 1, 2012. MLR premium rebates were designed to persuade health insurance companies to spend at least 80 percent of premiums directly on health care as opposed to advertising, certain administrative costs and executive salaries.

The average rebate per household is $151, but with averages ranging from $807 for Vermont to $0 for New Mexico and Rhode Island. Examples of other average household rebates reported by HHS include Calif. ($65), Fl. ($168), N.Y. ($138), Ill. ($380) and Texas ($187). Therefore, while the majority of those estimated 80 million individuals covered by health insurance will not be entitled to the MLR rebates, enough are to raise questions.

Whether a particular MLR rebate paid out this summer is taxable will depend upon a number of variables. Some individuals are receiving their premium rebate checks directly from the health insurance provider. Many more are receiving the rebate payments indirectly from their employers, either as cash payments or in the form of 2012 premium offsets. Some employers are using the rebates to cover plan expenses.

Labor Department rules

Department of Labor Technical Release 2011-04 provides guidance to employers on whether the portion of any rebate attributable to previous employer-paid premiums constitutes plan assets or whether they belong to the employer. Distinctions are made between situations in which the group health plan is considered the policyholder and when the employer is the policyholder, as well as whether contractual terms and the parties’ understandings and representations allow the employer to retain the distribution. DOL guidance also provides employers with some discretion as to how to use or dispose of their MLR rebates, as long as they “act prudently, solely in the interest of the plan participants and beneficiaries, and in accordance with the terms of the plan.”

Federal tax consequences

The basic rule of thumb in determining whether your MLR rebate is taxable is fairly straightforward: if a tax benefit was previously gained on the premiums now being refunded, the rebate is generally taxable; otherwise, the premiums are usually tax free to the recipient.

Individually-purchased policies. An individual who purchased and paid premiums for health insurance for himself or herself in 2011, without receiving any reimbursement or subsidy for the premiums, will not be taxed on any rebate received in 2012, provided the individual did not receive a tax benefit from deducting the 2011 premiums on 2011 Form 1040, Schedule A or, if self-employed, on line 29 of 2011 Form 1040. The same result applies whether the rebate is received in cash or as a reduction in the amount of premiums due for 2012.

Group policies—after-tax premium payments by employee. As is the case for individually-purchased policies, employees who in 2011 paid their share of the premiums on group policies with after-tax wages (income already taxed and subject to employment taxes) generally will not recognize income on 2012 MLR rebates. For employees who participated in the plan during 2011 and 2012 by paying after-tax premiums, the rebates—whether paid in cash or as a reduction in 2012 premiums—will be income tax free to them, except to the extent they benefited from deducting the premium on 2011 Form 1040.

One important exception: If the employer pays out the rebate based on the employee’s after-tax share of 2012 premiums irrespective of whether the individual was an employee in 2011, the employee receives the rebate as a tax-free purchase price adjustment to 2012 premiums paid. This tax-free treatment applies both to 2012 employees who were employees in 2011 and those who were not and, therefore, irrespective of whether any 2011 premiums were deducted on Form 1040, Schedule A.

Group policies—pre-tax premium payments by employee. MLR rebates are generally taxable if distributed to 2012 participants who pay premiums on a pre-tax basis under the employer’s cafeteria plan. If a 2011-2012 employee who paid in pre-tax premiums receives a rebate check, it is considered a return of wages that have not yet been taxed or subject to employment tax. If that employee receives the rebate in the form of a 2012 premium reduction, the employee’s payment of premiums through a salary reduction contribution in 2012 is decreased by that amount and therefore taxable salary is increased by that amount.

If an employer pays out rebates in 2012 irrespective of whether an employee under the cafeteria plan had worked for the employer in 2011, the MLR rebate is likewise considered additional income and subject to employment taxes. If paid in cash, it is considered additional wage income. If paid as a premium reduction, it is considered a reduction in the pre-tax amount due by the employee under the cafeteria plan and, therefore, increases wage income.

Information reporting
Rebate payments passed along by employers to employees under a cafeteria plan, either as cash or premium reductions, will normally be reflected on each employee’s Form W-2 as increased wage income, subject to income tax withholding and employment taxes.

Rebates that are not considered wage payments generally will only be subject to Form 1099-MISC information reporting if the payment equals or exceeds $600. Payments that are considered taxable must be reported by the individual policyholder irrespective of information reporting requirements.

Year-end tax planning amid legislative uncertainty

As 2013 draws closer, news reports about “taxmageddon” and “taxpocalypse,” describing expiration of the Bush-era tax cuts, are proliferating. Many taxpayers are asking what they can do to prepare. The answer is to prepare early. September may seem too early to be discussing year-end tax planning, but the uncertainty over the Bush-era tax cuts, incentives for businesses, and much more, requires proactive strategizing. Ultimately, the fate of these tax incentives will be resolved; until then, taxpayers need to be flexible in their year-end tax planning.

Individuals

In less than three months, the individual income tax rates are scheduled without further action to automatically increase across-the-board, with the highest rate jumping from 35 percent to 39.6 percent. Additionally, the current tax-favorable capital gains and dividends tax rates 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 tax code, will be cut in half. Millions of taxpayers are predicted to be liable for the alternative minimum tax (AMT) because of expiration of the AMT “patch.” Countless other incentives for individuals will either disappear or be substantially reduced after 2012.

In July, the House and Senate passed competing bills to extend many of these expiring incentives one more year (through 2013). No further action is expected on these bills until after the November elections. However, they do signal a highly probable temporary solution to the fate of the Bush-era tax cuts. Regardless of which party wins the White House and Congress, the probability of a one-year extension of the Bush-era tax cuts appears high.

Along with expiration of the Bush-era tax cuts, the two percent payroll tax holiday for 2012 is scheduled to expire. For individuals with income at or above the Social Security wage base for 2012 ($110,100), the payroll tax holiday represented a $2,202 savings. Unlike the Bush-era tax cuts, an extension of the payroll tax holiday is unlikely.

Putting aside the Bush-era tax cuts and the payroll tax holiday for a moment, two new taxes are scheduled to take effect after 2012: an additional 0.9 percent Medicare tax on wages and self-employment income and a 3.8 percent Medicare contribution tax on unearned income. Both new taxes are targeted to individuals with incomes over $200,000 (families with incomes over $250,000). One important misconception about the 3.8 percent Medicare tax is that it is a direct real estate tax. Taxpayers that dispose of real estate may be exempt from the tax either because of income limitations or because of an exclusion provided for primary residence home sales. However, certain high-end homes may feel the sting of the 3.8 percent tax on some or all of the gain realized. Despite some rumblings in the GOP-controlled House, it is unlikely the new Medicare taxes will be repealed before 2013.

All these provisions can be seen as the perfect storm. Year-end tax planning takes on new urgency because of the uncertainty. Some variations on traditional year-end planning techniques may be valuable. 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. The same strategy may apply to recognizing income from capital gains and dividends. Another valuable year-end strategy is to “run the numbers” for regular tax liability and AMT liability. Taxpayers may want to explore if 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. Additionally, keep in mind the new Medicare taxes and how they will impact investments and possibly home sales.

Estate tax planning is also in flux. Under current law, the maximum estate tax rate is 35 percent with an applicable exclusion amount of $5 million (indexed for inflation) for decedents dying before January 1, 2013. Unless Congress acts, the estate tax will revert to its less generous pre-2001 rates. Gift and generation-skipping transfer (GST) taxes also will revert to their pre-2001 rates.

Businesses

Businesses are also confronted with uncertainty in tax planning as 2012 ends. Special incentives, such as bonus depreciation, enhanced Code Sec. 179 expensing and a host of business tax extenders, may be unavailable after 2012.

Under current law, 50-percent bonus depreciation applies to qualified property acquired and placed in service after December 31, 2011 and before January 1, 2013 (January 1, 2014 for certain property). For tax years beginning in 2012, the Code Sec, 179 expensing dollar limitation is $139,000 and the investment ceiling is $560,000 for tax years beginning in 2012. After 2012, 50-percent bonus depreciation is scheduled to expire (except for certain property) and the Code Sec. 179 expensing dollar limitation will drop to $25,000 with a $200,000 investment ceiling.

Enhanced Code Sec. 179 expensing is a good candidate for extension after 2012, but at less generous amounts. In July, the Senate approved a Code Sec. 179 dollar amount of $250,000 and an $800,000 investment limitation for tax years beginning after December 31, 2012. The House approved a Code Sec. 179 dollar amount of $100,000 and a $400,000 investment limitation after 2012.

The list of expired business tax extenders is long. The expired incentives include the research tax credit, special expensing for film and television productions, the employer wage credit for military reservists, and many more. A host of related energy incentives have also expired and are awaiting renewal. Unlike past years, Congress is not expected to routinely extend all of the expired provisions. The more widely utilized incentives are likely to be extended; some lesser used incentives may not.

Businesses do have some good news in year-end planning. Temporary “repair” regulations issued in late 2011 include a valuable de minimis rule, which could enable taxpayers to expense otherwise capitalized tangible property. Qualified taxpayers may claim a current deduction for the cost of acquiring items of relatively low-cost property, including materials and supplies, if specific requirements are met. The aggregate cost which may be expensed annually under a taxpayer’s expensing policy is subject to a ceiling equal to the greater of 0.1 percent of gross receipts or two percent of total depreciation and amortization reported on the financial statement.

Businesses should also explore the Code Sec. 199 domestic production activities deduction. This deduction, unlike many other incentives, is permanent and will not expire after 2012. The deduction allows qualified taxpayers to deduct an amount equal to the lesser of a phased-in percentage of taxable income (adjusted gross income for individuals) or qualified production activities income. A taxpayer’s Code Sec. 199 deduction cannot exceed one-half (50 percent) of the W-2 wages paid by the taxpayer during the year.

Sequestration

The fate of the Bush-era tax cuts and the other incentives is linked to sequestration. The Budget Control Act of 2011 imposes across-the-board spending cuts starting in 2013. Many lawmakers want to postpone or repeal the spending cuts but savings must be recouped somehow. Several energy tax incentives, especially for oil and gas producers, have been viewed as likely candidates for elimination to offset repeal of the Budget Control Act.

Please contact our office at (908) 725-4414 if you have any questions about the incentives we discussed and how you can develop a year-end tax plan that responds to the current climate of uncertainty.