Vernoia, Enterline + Brewer, CPA LLC

Archive for April, 2014

FAQ: What is an information document request (IDR)?

When an IRS is conducting a detailed audit of a taxpayer, it may want to see documents and records retained by the taxpayer. The examiner will ask the taxpayer what type of documents are maintained, and will request that the taxpayer produce particular documents for inspection.

The IRS uses Form 4564, Information Document Request, to request information from a taxpayer for an audit. There are several versions of Form 4564, such as those for income tax audits, tax-exempt organizations, and tax-exempt bonds. Form 4564 will list documents needed to support taxpayer items that the IRS wants to verify. Taxpayers may want to consult with legal counsel to ensure that they do not provide too much information and do not provide privileged documents.

IDR enforcement

IRS_idrThe IRS has put into effect a new IDR enforcement process for IRS examiners to obtain information. In particular, the IRS’s Large Business and International Division (LB&I) issued several memos in 2013 and 2014 to provide guidance on the use of IDRs and to explain the new IDR enforcement process. Other divisions follow, or will be following, similar procedures.

Under the guidelines, examiners are instructed to prepare one IDR for each issue being examined; the IDR should describe the issue for which the documents are being requested. IDRs should be clear and concise, and customized to the taxpayer under audit. There is an exception to the requirement that the IDR state the issue. An initial IDR that requests basic books and records and general information about a taxpayer’s business does not have to meet this requirement.

Examiners are further instructed to discuss the proposed IDR with the taxpayer and to agree on a reasonable time for the taxpayer to respond. LB&I instituted a three-step process for enforcing the IDR, with strict deadlines: a delinquency notice; a pre-summons letter; and a summons. The process is mandatory. IRS Chief Counsel will enforce IDRs through summons issuance when necessary. The IRS may also apply this stricter process if it believes that the taxpayer’s response is incomplete.


If and only to the extent that this publication contains contributions from tax professionals who are subject to the rules of professional conduct set forth in Circular 230, as promulgated by the United States Department of the Treasury, the publisher, on behalf of those contributors, hereby states that any U.S. federal tax advice that is contained in such contributions was not intended or written to be used by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer by the Internal Revenue Service, and it cannot be used by any taxpayer for such purpose.

How do I? As an employer, report health insurance coverage?

One of the most complex, if not the most complex, provisions of the Patient Protection and Affordable Care Act is the employer shared responsibility requirement (the so-called “employer mandate”) and related reporting of health insurance coverage. Since passage of the Affordable Care Act in 2010, the Obama administration has twice delayed the employer mandate and reporting. The employer mandate and reporting will generally apply to applicable large employers (ALE) starting in 2015 and to mid-size employers starting in 2016. Employers with fewer than 50 employees, have never been required, and continue to be exempt, from the employer mandate and reporting.

Employer mandate

The employer mandate under Code Sec. 4980H and employer reporting under Code Sec. 6056 are very connected. Code Sec. 4980H generally provides that an ALE is required to pay a penalty if it fails to offer minimum essential coverage and any full-time employee receives cost-sharing or the Code Sec. 36B premium assistance tax credit. An ALE would also pay a penalty if it offers coverage and any full-time employee receives cost-sharing or the Code Sec. 36B credit.

To receive the Code Sec. 36B credit, an individual must have obtained coverage through an Affordable Care Act Marketplace. The Marketplaces will report the names of individuals who receive the credit to the IRS. ALEs must report the terms and conditions of health care coverage provided to employees (This is known as Code Sec. 6056 reporting). The IRS will use all of this information to determine if the ALE must pay a penalty.

ALEs

Only ALEs are subject to the employer mandate and must report health insurance coverage under Code Sec. 6056. Employers with fewer than 50 employees are never subject to the employer mandate and do not have to report coverage under Code Sec. 6056.

In February, the Obama administration announced important transition rules for the employer mandate that affects Code Sec. 6056 reporting. The Obama administration limited the employer mandate in 2015 to employers with 100 or more full-time employees. ALEs with fewer than 100 full-time employees will be subject to the employer mandate starting in 2016. At all times, employers with fewer than 50 full-time employees are exempt from the employer mandate and Code Sec. 6056 reporting.

Reporting

The IRS has issued regulations describing how ALEs will report health insurance coverage. The IRS has not yet issued any of the forms that ALEs will use but has advised that ALEs generally will report the requisite information to the agency electronically.

ALEs also must provide statements to employees. The statements will describe, among other things, the coverage provided to the employee.

30-Hour Threshold

A fundamental question for the employer mandate and Code Sec. 6056 reporting is who is a full-time employee. Since passage of the Affordable Care Act, the IRS and other federal agencies have issued much guidance to answer this question. The answer is extremely technical and there are many exceptions but generally a full-time employee means, with respect to any month, an employee who is employed on average at least 30 hours of service per week. The IRS has designed two methods for determining full-time employee status: the monthly measurement method and the look-back measurement method. However, special rules apply to seasonal workers, student employees, volunteers, individuals who work on-call, and many more. If you have any questions about who is a full-time employee, please contact our office.

Form W-2 reporting

The Affordable Care Act also requires employers to disclose the aggregate cost of employer-provided health coverage on an employee’s Form W-2. This requirement is separate from the employer mandate and Code Sec. 6056 reporting. The reporting of health insurance costs on Form W-2 is for informational purposes only. It does not affect an employee’s tax liability or an employer’s liability for the employer mandate.

Shortly after the Affordable Care Act was passed, the IRS provided transition relief to small employers that remains in effect today. An employer is not subject the reporting requirement for any calendar year if the employer was required to file fewer than 250 Forms W-2 for the preceding calendar year. Special rules apply to multiemployer plans, health reimbursement arrangements, and many more.

Please contact our office at (908) 725-4414 if you have any questions about ALEs, the employer mandate or Code Sec. 6056 reporting.

IRS clarifies IRA rollover rule after Tax Court nixes multiple rollovers

In January, the U.S. Tax Court threw a curve ball in many retirement planning strategies. The court held that a taxpayer could make only one nontaxable rollover contribution within each one-year period regardless of how many IRAs the taxpayer has. The court found that the one-year limitation under Code Sec. 408(d)(3)(B) is not specific to any single IRA owned by an individual but instead applies to all IRAs owned by a taxpayer. The court’s decision was a departure from a long-time understanding of IRS rules and publications and, for several weeks after, it was unclear what approach the IRS would take. Now, the IRS has announced that it will follow the court’s decision and revise its rules and publications. Everyone contemplating an IRA rollover needs to be aware of this important development.

Rollovers

Individuals have traditionally enjoyed flexibility in moving their retirement savings from one type of retirement plan to another type of plan. A rollover is a transfer of a distribution received from an IRA or other retirement plan by the recipient to another IRA or type of retirement plan owned by the same recipient. A rollover has important tax considerations. The amount distributed is not included in the recipient’s income if the distribution is transferred to an eligible arrangement within 60 days after it is received. In certain cases, the 60-day period may be extended by the IRS.

Generally, only the owner of the IRA may roll over an amount. A surviving spouse who receives a distribution after the death of the account owner can make rollovers to the same extent as the account owner could have. There are also special rules for Roth IRAs and other retirement arrangements.

Tax Court case

In Bobrow, TC Memo. 2014-21, a married couple received distributions from more than one IRA in 2008. The couple claimed that they could make more than one tax-free rollover. The Tax Court disagreed.

The court found that Code Sec. 408(d)(3)(B) limits the frequency with which a taxpayer may make a nontaxable rollover contribution. The one-year limitation is not specific to any single IRA a taxpayer has but instead applies to all of the taxpayer’s IRAs. If Congress had intended to allow individuals to take nontaxable distributions from multiple IRAs per year, the court found that Code Sec. 408(d)(3)(B) would have been worded differently.

Immediately after the decision, many benefits professionals pointed out that the IRS’s rules and publications appeared to be contrary to the court’s decision. In particular, many taxpayers noted that IRS Publication 590, Individual Retirement Plans, seemed to say that multiple rollovers were permissible if taken from different accounts.

IRS action

The IRS intends to amend the existing rules and revise Publication 590 to clarify that it will adopt the court’s decision. Additionally, many IRA trustees, the IRS explained, may need time to make changes to reflect Bobrow. Therefore, in a relief measure, the IRS will not apply the Tax Court’s decision to any rollover that involves an IRA distribution occurring before January 1, 2015.

Trustee-to-trustee transfers

A rollover must be distinguished from a trustee-to-trustee transfer. The Tax Court explained in its opinion that individuals who maintain more than one IRA may make multiple direct rollovers from the trustee of one IRA to the trustee of another IRA without triggering the one-year limit under Code Sec. 408(d)(3)(B). Transferring funds directly between trustees, the court found, does not result in a distribution within the meaning of Code Sec. 408(d)(3)(A). Since the funds are not within the direct control and use of the participant, they are not considered to be rollovers.

Planning

The court’s decision and the IRS’s action may impact your retirement planning. Keep in mind also that trustee-to-trustee transfers are not affected by the court’s decision, which leaves some flexibility intact for planning. If you have any questions about IRA rollovers, please contact our office at (908) 725-4414.

Competing proposals fuel tax reform discussions

Tax reform, frequently discussed in Washington, got a boost from two recent proposals, one from the chair of the House tax writing committee and another from the White House. Rep. Dave Camp, R-Mich., chair of the House Ways and Means Committee, released a massive tax reform bill in late February. In early March, President Obama released his fiscal year (FY) 2015 budget proposals, detailing over 160 tax proposals. Both proposals share some similarities but also key differences.

Camp’s plan

Camp unveiled a sweeping tax reform plan (the Tax Reform Act of 2014) that would leave almost no part of the Tax Code unchanged. Everyone-individuals, businesses, exempt-organizations, governmental entities-would be impacted in one way or another. Some of Camp’s far-reaching proposals are:

  • Consolidation of individual tax brackets
  • Higher standard deduction
  • Increased child tax credit
  • Revised treatment of capital gains and dividends with a 40 percent exemption
  • Repeal of alternative minimum tax (AMT)
  • Consolidated education tax incentives
  • Simplified tax return for seniors
  • Reform of charitable contribution deduction
  • Modified home mortgage interest deduction
  • Top corporate tax rate of 25 percent
  • Reform of rules for depreciation
  • Permanent research tax credit
  • Reform of the casualty loss rules

To pay for lower tax rates, Camp’s proposal would repeal many popular current tax incentives for individuals. They include the state and local sales tax deduction, higher education tuition deduction, student loan interest deduction, residential energy efficiency credits, adoption credit, and the itemized medical expense deduction. Many tax-advantage benefits of retirement plans would be curtailed or eliminated. Businesses also would lose many tax incentives, such as the Code Sec. 199 domestic production activities deduction, credits for production of fossil and alternative fuels, and the Work Opportunity Tax Credit. Camp’s plan would also repeal the like-kind exchange rules, the last-in, first-out (LIFO) method of accounting, and reform the rules for the treatment of travel and entertainment expenses. The foreign tax system would also be overhauled.

Camp did not propose to repeal the Patient Protection and Affordable Care Act. Camp did, however, propose to repeal the Affordable Care Act’s medical excise tax and prohibition of using health FSA dollars for over-the-counter medications. Camp has supported separate bills to delay the Affordable Care Act’s individual mandate but did not address this in his tax reform plan.

Obama’s proposals

President Obama’s FY 2015 budget renews a number of past proposals and makes some new proposals. New proposals include significant enhancements to the child tax credit and the earned income credit. President Obama did not go so far as Camp to propose reducing the number of individual tax brackets but he did call for reducing the value of certain exclusions and deductions for higher income individuals and imposing a minimum tax rate of 30 percent on individuals with adjusted gross incomes above $1 million. For homeowners, the President proposed to extend the now-expired exclusion for cancellation of certain home mortgage debt. In the education area, the President called on Congress to make permanent the AOTC.

As in his past budget proposals, President Obama also signaled his willingness to reduce the corporate tax rate but businesses would need to give up some tax incentives in exchange. These could include many of the so-called business tax extenders, such as special expensing rules for television productions, environmental remediation and similar ones. The President did propose to permanently increase Code Sec. 179 small business expensing to $500,000 with a $2 million investment limit. However, bonus depreciation would not be extended.

Outlook

Several of the President’s proposals are similar to ones from Camp. The President called for repealing the last-in, first-out (LIFO) method of accounting and many fossil fuel preferences. A new proposal would limit the amount of capital gain deferred under Code Sec. 1031 from a like-kind exchange of real property to $1 million per taxpayer per year, effective for exchanges completed after December 31, 2014. Both the President and Camp proposed to make permanent the research tax credit. They differed significantly on which other temporary incentives to continue or eliminate.

The GOP-controlled House is not expected to take up many of President Obama’s proposals, with the possible exception of some tax administration changes. The President’s budget received a more enthusiastic response from Senate Democrats, but passage in the Senate requires a supermajority of 60 votes, which Democrats lack. The outlook for Camp’s proposals is equally murky. As chair of the Ways and Means Committee, Camp may schedule hearings on his plan but the House GOP leadership ultimately must bring the bill to the full House for a vote, and it is unlikely to do so this year.

If you have any questions about the President’s proposals or Camp’s bill, please contact our office (908) 725-4414

IRS takes aim at employment tax compliance

The current likelihood that your business will become involved in an employment tax audit or an employment-related income tax audit has increased: the IRS is aggressively attempting to reduce the “tax gap” of uncollected revenues in a time of increasing budget austerity. Employment tax noncompliance is estimated by the IRS to account for approximately $54 billion of the tax gap. Under-reporting of FICA makes up $14 billion; under-reporting of self-employment tax accounts for $39 billion; and under-reporting of unemployment tax accounts for $1 billion in lost revenue. Add to that total amount over $50 billion in estimated employment-associated income tax lost that are the result of missteps in withholding obligations, tip reporting, and proper fringe benefit classification . . . and employers are forewarned. The IRS is stepping up its auditing in these areas and has been conducting studies to maximize the best use of its agents’ time to do so.

Latest audit survey

The IRS is conducting an intensive audit of 6,000 employment tax returns to obtain an up-to-date picture of taxpayers’ employment tax practices. This will enable the IRS to better devote its compliance resources to the most important areas of noncompliance and to the taxpayers most likely not to be in compliance.

Based on these audits, the IRS’s Chief of Employment Tax Policy has spotlighted several areas of concern that the IRS will focus on. These areas include backup withholding, tip reporting, worker classification, and fringe benefit reporting.

Backup withholding. Backup withholding is the number one problem uncovered in the audits. The IRS can impose backup withholding on income reported on Forms 1099 that is not ordinarily subject to withholding, such as interest, dividends, and nonemployee compensation. Failure to provide a taxpayer identification number (TIN) on the Form 1099, an incorrect TIN, or a TIN that does not match the name on the form can trigger backup withholding. A taxpayer’s failure to report the income can also trigger backup withholding.

Tip reporting. Tip reporting is a major concern of the IRS. The IRS considers noncompliance a widespread problem, especially for small businesses that are not aware of the issues. The IRS has been focusing on educating employers, and is not auditing employment tax returns filed before 2014. An important issue is the failure to differentiate between service charges and tips. A payment that is automatically added to a bill may be a service charge. A service charge is characterized as Social Security wages, rather than Social Security tips. The distinction is important, because employers can claim a Social Security credit for FICA obligations attributable to tips that exceed the minimum wage, but cannot claim a credit for taxes paid on service charges.

Worker misclassification. To avoid FICA and FUTA taxes and income tax withholding, some employers intentionally classify employees as independent contractors. This has been a longstanding concern for the IRS, and the recent audits have shown that the problem continues. The agency regularly conducts employment tax audits to reclassify workers as employees. To facilitate reclassification to employee status, the IRS has two settlement programs for employers: the Classification Settlement Program (CSP) for taxpayers under audit, and the Voluntary Classification Settlement Program (VCSP) for companies that are not under an employment tax audit and meet other requirements. The IRS has received 1,550 applications under the VCSP and has reclassified approximately 25,000 workers. Companies that agree to prospectively treat workers as employees generally pay reduced taxes and may get audit protection for past years.

Fringe benefit reporting. Fringe benefits can be cash or noncash benefits provided in addition to regular wages. As a compliance matter, fringe benefits are taxable and must be included in the recipient’s income, unless the Tax Code specifically excludes the benefit from taxable income. Moreover, if the recipient is an employee, the value of the benefit is additional compensation subject to employment taxes. Fringe benefits can be a particular problem for small companies, where owners seek to reduce their taxable income by taking noncash benefits, such as the use of company vehicles. A bargain sale of a house to an employee could also generate taxable income subject to employment taxes.

Conclusions

Employment taxes present an increasing risk to employers as the IRS steps up focuses on what it suspects is a heretofore largely untapped source of revenue. The IRS is certain to use the data now being harvested through its latest audit surveys. Many employers may do well to review how their employment tax compliance now measures up to this new degree of scrutiny.