Education Tax Breaks

November 26, 2016

Tax breaks to help you pay educational expenses are some of the most commonly overlooked federal tax breaks. They shouldn’t be. These are very valuable tax breaks and we can help you maximize your tax savings.
 
Getting the most from the education tax incentives requires careful planning, particularly because of the interrelationship between many of the rules. Although the IRS provides guidance, some of the IRS’ explanations have actually complicated matters in some circumstances.
 
Let’s take a look at some of the education tax incentives:
 
American Opportunity Tax Credit. The American Opportunity Tax Credit (AOTC) provides a maximum credit amount of $2,500 per year for four years of post-secondary education The AOTC is computed as 100 percent of up to $2,000 qualified higher education expenses plus 25 percent of the next $2,000 of eligible expenses. The AOTC begins to “phase out” for married couples filing jointly with adjusted gross income (AGI) between $160,000 and $180,000. The AOTC begins to phase out for single individuals with AGI between $80,000 and $90,000. Forty percent of the AOTC is refundable for those lower-income taxpayers with a tax liability smaller than the credit amount.
 
To qualify for the AOTC, the tuition must be paid on behalf of the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent. An eligible student for purposes of the credit is an individual who is enrolled in a degree, certificate or other program leading to a recognized educational credential at an eligible educational institution. The student must be enrolled at least half-time and must not have been convicted of a federal or state felony for possession or distribution of a controlled substance. Study at many types of post-secondary institutions qualifies for the credit, such as programs for a bachelor’s degree, associate’s degree or another recognized post-secondary credential.
 
Lifetime Learning credit. The Lifetime Learning credit can be claimed for an unlimited number of tax years. The Lifetime Learning credit equals 20 percent of up to $10,000 in eligible education costs during the tax year. The Lifetime Learning credit is subject to phase-out rules based on adjusted gross income.
 
The Lifetime Learning credit may be applied to a non-degree program. For example, an individual who is enrolled in a non-degree program to improve job skills may be eligible for the credit. Moreover, the Lifetime Learning credit may be claimed even if the student is not enrolled at least half-time. An individual who is taking just one class at a community college, for example, may be eligible for the credit.
 
Higher education deduction. Eligible taxpayers can claim an above-the-line deduction for qualified tuition and related expenses. Eligible expenses include those spent on behalf of the taxpayer, his or her spouse or dependents at a post-secondary institution. The college or school must be eligible to participate in the federal student loan program. The amount of the deduction depends on your AGI.
 
As an above-the-line deduction, the deduction for qualified tuition and related expenses could be taken even if the taxpayer does not itemize deductions, and it is not subject to the two-percent floor.
 
Unless this tax benefit is extended again, it is not available after 2016.
 
Section 529 plans. The Tax Code allows states and some educational institutions to offer “529” plans (known for the section of the Tax Code that governs them). They are also sometimes called qualified tuition programs (QTPs). They allow you to either prepay or contribute to an account for paying a student’s post-secondary education expenses. An eligible educational institution generally includes colleges, universities, vocational schools or other post-secondary educational institutions. In addition, distributions from state programs, even to the extent of earnings, are now entirely tax-free to the extent used for qualified higher education expenses.
 
Qualified higher education expenses include tuition, fees, books, supplies, and equipment required for the beneficiary’s enrollment at an eligible educational institution, which includes most institutions that participate in federal student aid programs. The cost of computers or peripheral equipment, computer software, and internet access and related services also qualify as higher education expenses. If the student is attending an institution at least half-time, room and board is treated as a qualified expense.
 
Coverdell education savings accounts. Coverdell education savings accounts (also sometimes called education IRAs) are similar to IRAs. You can save today for future educational expenses and not just higher educational expenses. Funds in a Coverdell ESA can also be used for K-12 and related expenses. The American Taxpayer Relief Act made permanent some temporary enhancements to Coverdell ESAs.  The maximum annual Coverdell ESA contribution is $2,000 per beneficiary. Contributions are not deductible by the donor and are not included in the beneficiary’s income as long as they are used to pay for qualified education expenses.
 
Contributions generally must stop when the beneficiary turns age 18 except for individuals with special needs. Parents can maximize benefits, however, by transferring older siblings’ accounts for use by a younger brother, sister or first cousin, thereby maximizing the tax-free growth period. Excess contributions are subject to an excise tax.
 
The phase-out amounts of adjusted gross income allowed for a contributor to a Coverdell ESA are generous. The annual contribution starts to phase out for married couples filing jointly with modified AGI at or above $190,000 and less than $220,000 and at or above $95,000 and less than $110,000 for single individuals.
 
Many individuals find Coverdell education savings accounts attractive because distributions can be used for room and board (if the designated beneficiary is enrolled at least half-time) as well as for qualified tuition and the costs of books and supplies required for enrollment. Beneficiaries who have special needs may also find these expenses qualify.
 
Education savings bond interest exclusion. When you use U.S. savings bonds to pay qualified higher education expenses, the interest may be excluded from income if your income is below a certain range. Qualified education expenses include the cost of tuition and fees at an eligible educational institution for the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent at an eligible educational institution. Colleges, universities and vocational schools that participate in federal student aid programs generally qualify for the incentive.
 
For bond interest to be excluded, the taxpayer must have attained the age of 24 before the issue date of the bonds. Qualified bonds must also be issued in the name of the taxpayer as sole owner or in the name of the taxpayer and the taxpayer’s spouse as co-owners. Married taxpayers must file a joint return to exclude bond interest.
 
Employer-provided educational assistance exclusion. When an employer pays an employee’s education expenses, the tax consequences depend on the reason for the education. Your employer may have a plan under which it pays for qualified education expenses for college or graduate studies. If it has such a plan, up to $5,250 of education benefits can excluded from the recipient’s gross income each year. Employer-provided educational assistance can include tuition, fees, books, supplies and equipment.
 
Job-related educational expenses. If you are taking a course because it is directly related to improving your job performance and your employer does not cover it, you may be able to deduct it as a miscellaneous itemized deduction if you itemized deductions. Under this deduction, tuition, course materials, and even the cost of transportation to and from class may be deductible. There are some restrictions, however: miscellaneous deductions are deductible only in excess of two percent of your adjusted gross income; and any degree program that qualifies you for a “new trade or business” cannot be deducted under this provision no matter how helpful it also may be to your present job.
 
Deduction for interest on education loans. Student loan interest of up to $2,500 a year is deductible whether or not you itemize your deductions. The deduction is completely phased when a taxpayer’s modified AGI exceeds certain thresholds. Only those legally obligated to make the loan payments may deduct them. Individuals who are claimed as dependents on another person’s return cannot take this deduction. Qualified educational institutions for the student loan interest deduction are generally ones that participate in federal student aid programs.
 
IRAs. The Tax Code also allows individuals under age 59 1/2 to take distributions from an IRA for qualified higher education expenses without having to pay the 10 percent early withdrawal penalty. The qualified education expenses generally must be for the IRA holder, his or her spouse, or a child (including a foster child). Qualified education expenses include tuition, books and supplies. Room and board is also a qualified expense if the individual is at least a half-time student. An eligible education institution is generally one that participates in federal student aid programs.
 
Coordination. As you have read, there are many federal education tax incentives. All of the incentives must be coordinated; that is, you may not be able to take everyone. You generally cannot use education expenses to claim a double benefit. Many taxpayers make genuine and honest mistakes when trying to coordinate the education incentives without help from a tax professional. These mistakes are very costly. If you are considering claiming any of the education incentives, please contact our office.

IRS provides relief to all affected by the Boston tragedy

April 17, 2013

The IRS has announced a three-month filing and payment extension for taxpayers and others affected by the events in Boston on Monday. According to the IRS, This relief applies to all individual taxpayers who live in Suffolk County, Mass., including the city of Boston. It also includes victims, their families, first responders, others impacted by this tragedy who live outside Suffolk County, and taxpayers whose tax preparers were adversely affected. Read a copy of the IRS Notice here.

No filing and payment penalties will be due as long as returns are filed and payments are made by July 15, 2013.

Sunset Provisions: Business and Investment

September 3, 2012

Many of the “Bush-era” tax cuts are scheduled to sunset at the end of 2012. The “Bush-era” tax cuts is the collective term for the tax measures enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). These two Acts made changes to over 50 provisions of the Internal Revenue Code and impacted a wide variety of taxpayers. However, in order to comply with budget requirements, the changes are scheduled to expire. In a presidential election year, it is not clear what, if anything, Congress will do to extend these tax cuts. This uncertainty in the tax law generates a myriad of complexities for taxpayers and tax professionals.

The following are highlights of some of the business and investment tax cuts scheduled to expire after 2012 and what might happen if they are not extended.

Capital Gains

The reduced maximum capital gains rate of 15 percent on adjusted net capital gain of noncorporate taxpayers and the zero percent capital gains rate on adjusted net capital gain of noncorporate taxpayers in the 10-percent and 15-percent income tax bracket are scheduled to expire for tax years beginning after December 31, 2012.

Impact – Absent extension, the maximum tax rate on net capital gain of noncorporate taxpayers will revert to 20 percent (10 percent for taxpayers in the 15 percent bracket) after 2012. Thus, the acceleration of the sale of capital assets into 2012 while the tax rates are lower is one strategy for taxpayers to consider. As long as the sale is bona fide, and the proceeds are received in 2012, capital gains can be accelerated. The “wash sale” rules that apply to claiming losses do not apply to gains. Accordingly, capital gains can be recognized at any time and, immediately thereafter, the identical asset can be repurchased, with a new tax basis established in the amount of the purchase price.

Accordingly, installment payments received after 2012 are subject to the tax rates for the year of the payment, not the year of the sale. Thus, the capital gains portion of payments made in 2013 and later may be taxed at the 20 percent rate.

Five-Year Holding Period for Capital Assets

There is no special capital gain treatment in 2011 or 2012 for property held for more than five years. After 2012, the JGTRRA-based lower capital gain rates for five-year gain of individuals, estates and trusts are scheduled to be revived. Long-term gain on the sale or exchange of property held for more than five years generally will be taxed at 18 percent (eight percent for taxpayers in the 15 percent bracket).

Impact – For higher-income taxpayers, the 15 percent rate applies if the taxpayer has held the asset for more than one year, but only if the taxpayer sells the asset by no later than December 31, 2012. The 18 percent rate for qualified five-year property applies if the taxpayer acquired the asset in 2001 or later, has held the asset for more than five years, and sells it after December 31, 2012. The 20 percent rate applies if the taxpayer acquired the asset in 2001 or later, sells the asset after December 31, 2012 and has held the asset for more than one but not more than five years; or has held the asset for more than five years but acquired the asset by exercising an option, right or obligation to acquire the property and the taxpayer has held such since before 2001.

Dividends

The 2010 Tax Relief Act extended the reduced net capital gains tax rates for qualified dividends through 2012. These rates had originally been enacted by JGTRRA. The maximum tax rate for qualified dividends received by an individual is 15 percent for tax years beginning before January 1, 2013. A zero percent rate applies to qualified dividends received by an individual in the 10 or 15 percent income tax rate brackets.

Impact – Absent extension, qualified dividends will be taxed at the applicable ordinary income tax rates after 2012 (with the highest rate scheduled to be 39.6 percent). Qualified corporations may want to explore declaring a special dividend to shareholders before January 1, 2013. President Obama’s proposed fiscal year (FY) 2013 federal budget recommended increasing the dividends rate to the ordinary income tax rate for higher-income individuals.

Other Dividend-Related Provisions

The following business-entity related tax breaks associated with dividends are also scheduled to sunset after 2012:

Dividends received from a regulated investment company (RIC), real estate investment trust (REIT) and other qualified pass-through entities are treated as qualified dividends for purposes of the reduced tax rates through 2012;
Temporary repeal of the collapsible corporation rule will end after 2012;
The accumulated earnings tax rate imposed on corporations which had been reduced to 15 percent will rise to 39.6 percent after 2012; and
The tax on undistributed personal holding company (PHC) income will also rise from its temporary 15 percent rate to the highest individual tax rate.

Uncertainty is always a factor in tax planning. In 2012, uncertainty is magnified by the unknown fate of countless tax provisions on which taxpayers have relied in recent years. The uncertainty is expected to continue until after 2012 elections; and maybe even into 2013. Our office can help you plan for all of this uncertainty, by adopting strategies that allow you to remain flexible for as long as possible while being prepared to act on opportunities before they are lost to time and changing laws. Making plans now to accelerate certain income, defer specific deductions, and realize capital gains are only some of the strategies that might fit your situation.

 

 

 

Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

Take Advantage of Lower Tax on Capital Gains

December 18, 2011

Long-term capital gains and qualified dividends continue to be taxed at favorable rates through 2012. For middle- and higher-income investors, these items are taxed at a maximum rate of 15 percent, a much lower rate than ordinary income. Taxpayers in the 10 and 15 percent ordinary income brackets do not pay any taxes on long-term gains and qualified dividends. Short-term gains are taxed at ordinary income rates.

To obtain long-term rates, investors must hold the asset (such as stock and most other property) for more than one year. The holding period begins on the day after you acquire the asset and ends on the day you dispose of the asset.

Example. If you bought stock on November 30, 2010 and sold it November 30, 2011, your holding period is exactly one year, and any gain (or loss) is short-term. If you instead sold the stock on December 1, 2011, your holding period is more than one year, and gains (or losses) are long-term.

Rates on long-term gains may increase dramatically after 2012, depending on the status of the Bush-era tax rates. Long-term rates will increase to 20 percent if Congress takes no further action. The Obama administration has proposed to reinstate the 20 percent rate, but only for individual taxpayers with income of $200,000 and married taxpayers with income of $250,000. To ensure that you can take advantage of long-term rates in 2012, you may want to make particular stock purchases before the end of 2011. For 2011, December 30 is the last day on which stock exchanges are open, since December 31, 2011 is a Saturday.

2011 Second Quarter Federal Tax Developments

July 27, 2011

During the second quarter of 2011, there were many important federal tax developments. This highlights some of the more important federal tax developments for you. As always, please give our office a call or send us an email if you have any questions about these developments.

Mileage rates. The IRS announced a mid-year adjustment to the 2011 optional mileage rates to reflect an increase in gasoline prices since the rates were set in late 2010. The business standard mileage rate rises to 55.5 cents-per-mile and the medical/moving standard mileage rate to 23.5 cents-per-mile, both representing a 4.5 cents-per-mile increase for the second half of 2011. The charitable standard mileage rate, which is determined by statute, is unchanged for the second half of 2011.

Information reporting. In April, President Obama signed the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 (2011 Taxpayer Protection Act) (P.L. 112-9). Previously, the Patient Protection and Affordable Care Act (PPACA) (P.L. 111-148) required businesses, charities and government entities to file information returns (Form 1099) for all payments of $600 or more in a calendar year to a single vendor, other than to a tax-exempt vendor, made after December 31, 2011. The PPACA also repealed the long-standing reporting exception for payments made to corporations. The Small Business Jobs Act of 2010 (2010 Small Business Jobs Act) (P.L. 111-240), required landlords to file a Form 1099 to report certain rental property expense payments of $600 or more in conjunction with their rental properties. Reporting under the 2010 Small Business Jobs Act was mandated for qualified payments made after December 31, 2010. The new law repeals these reporting requirements as if they had never been enacted.

Foreign accounts. In February 2011, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued final rules under the Bank Secrecy Act for reporting certain foreign accounts. Subsequently, the IRS and FinCEN announced a one-year extension of filing Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) for certain individuals and certain financial professionals with signature authority over, but no financial interest in, foreign financial accounts. Additionally, the IRS suspended certain information reporting requirements under the Foreign Account Tax Compliance Act (FATCA) title of the Hiring Incentives to Restore Employment (HIRE) Act (P.L. 111-147).

In January 2011, the IRS announced an offshore voluntary disclosure initiative (OVDI) to encourage taxpayers to report undisclosed foreign accounts. In exchange for making voluntary disclosure of unreported foreign accounts and fully cooperating with the IRS, taxpayers may be eligible for a reduced penalty framework. The 2011 OVDI will be available only through August 31, 2011. In limited situations, however, the IRS will consider extending that deadline for up to 90 days upon a taxpayer’s request and a good faith showing that all relevant materials cannot be submitted by the August 31, 2011 deadline. The IRS also provided opt-out procedures.

Filing season. As of the morning of the April 18 filing deadline, IRS reported that e-filed tax returns had topped the 100 million mark during the 2011 tax filing season, a record for e-filing. The 100 million figure represents an 8.8 percent increase from the 2010 tax season.

Basis. In Carpenter Family Investments, LLC, 136 TC No. 17, the Tax Court rejected IRS regulations that impose an extended six year limitations on assessments due to overstated basis. The court found that events since its last decision on the issue – namely, issuance of final regulations and Supreme Court’s Mayo (131 SCt 704 (2011) decision – did not change its holding that the IRS is limited to the general, three-year limitations period in basis-overstatement situations.

Whistleblower awards. The IRS whistleblower program was significantly overhauled in the Tax Relief and Health Care Act of 2006 (P.L. 109-432). In April, the IRS described how the agency may pay whistleblower awards and impose income tax withholding on awards. Additional guidance is expected as the agency moves forward in finalizing proposed regulations, the IRS reported.

Withholding. The IRS issued final regulations explaining when governmental entities must withhold three percent on payments they make to contractors providing property or services. The final regs delay the effective date of the withholding requirement until payments made after December 31, 2012. Among other provisions, the regulations will generally only apply to payments of $10,000 or more. The withholding requirement, enacted in the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222), remains controversial and is the subject of numerous repeal measures in Congress.

Health care reform. In April, the IRS expanded interim relief from reporting the cost of employer-provided health insurance coverage on Forms W-2, Wage and Tax Statement. Under the Patient Protection and Affordable Care Act (PPACA) (P.L. 111-148), employers generally are required to report the cost of coverage on Forms W-2 starting with Forms W-2 issued in 2012 for the 2011 tax year. In Notice 2010-69, the IRS issued interim relief, making reporting optional for all employers for 2011. Notice 2011-28 provides further relief.

The IRS released in May a framework on how it may implement the employer’s shared responsibility requirements under the Patient Protection and Affordable Care Act (PPACA) (P.L. 111-148). The framework describes which employers may be affected and how the number of employees and any assessable payments will be calculated. The PPACA does not require employers to provide health insurance to their employees but imposes assessable payments on certain large employers after 2013 that generally fail to offer full-time employees the opportunity to enroll in minimum essential coverage under an employer plan or offer full-time employees the opportunity to enroll in minimum essential coverage but, among other things, the minimum essential coverage is unaffordable and an employee receives a tax credit or cost-sharing.

Health savings accounts. The IRS provided inflation-adjusted amounts for health savings accounts (HSAs) for 2012. The amounts generally increased from 2011. For calendar year 2012, the annual contribution limit for an individual with self-only coverage under a high deductible health plan (HDHP) is $3,100, up from $3,050 for calendar-year 2011. The corresponding limit for an individual with family coverage under an HDHP is $6,250, up from $6,150 for calendar-year 2011. For calendar year 2012, an HDHP is defined as a health plan with an annual deductible that is not less than $1,200 for self-only coverage and $2,400 for family coverage. These amounts are unchanged from calendar year 2011.

Killer B transactions. The IRS issued final regulations that target so-called Killer B stock-for-stock triangular reorganizations that some domestic parents have used to repatriate the earnings of foreign subsidiaries tax-free. The final regulations generally track proposed regulations issued in 2008, and apply to transactions occurring on or after May 19, 2011.

Innocent spouse relief. In June, the Court of Appeals for the Fourth Circuit upheld the two-year limitations period for requesting Code Sec. 6015(f) equitable innocent spouse relief (Jones, CA-4, June 14, 2011). The Fourth Circuit concluded that the regulations represented a reasonable approach to resolving ambiguity. The Tax Court previously found the regulations invalid.

FUTA surtax. The 0.2 percent federal unemployment act tax (FUTA) surtax expired after June 30, 2011. Prior to July 1, 2011, FUTA was made up of the permanent 6.0 percent rate and the 0.2 percent surtax for a combined tax rate of 6.2 percent. The 0.2 percent surtax, originally enacted in 1976, had been extended by the Worker, Homeownership and Business Assistance Act of 2009 (2009 Worker Act) (P.L. 111-92) through 2010 and the first six months of 2011. As a result of the expiration of the surtax, the FUTA tax rate falls to 6.0 percent before any state unemployment tax credits are taken into account.

If you have any questions about these or any federal tax developments, please contact our office.

 Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

2011 First Quarter Federal Tax Developments

May 5, 2011


During the first quarter of 2011, there were many important federal tax developments. Here are some of the more important ones. As always, please give our office a call or send us an email if you have any questions about these developments.

Federal taxes

President Obama released his fiscal year (FY) 2012 federal budget recommendations in February. The president proposed to extend the Bush-era income tax rate reductions for all taxpayers except for higher income taxpayers (which the White House defines as individuals with incomes over $200,000 and married couples with incomes over $250,000). The president also proposed, among other things, to make permanent the American Opportunity Tax Credit and extend some popular but temporary individual tax incentives. For businesses, the president proposed, among other things, to make permanent the research tax credit.

Bonus depreciation

The IRS issued much-anticipated guidance on 100 percent bonus depreciation (enacted by the Tax Relief, Unemployment Reauthorization Extension and Job Creation Act of 2010). The IRS explained the relationship between 100 percent bonus depreciation and 50 percent bonus depreciation (enacted by the Small Business Jobs Act of 2010). The IRS also allowed, among other things, businesses to elect to deduct 50 percent bonus depreciation instead of 100 percent bonus depreciation in certain situations.

Information reporting

Congress passed the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 (2011 Taxpayer Protection Act) to repeal expanded information reporting on Form 1099 for certain business payments and rental property expense payments. The provisions had been widely criticized as being unduly burdensome on taxpayers, especially small businesses.

Filing season

Due to observance of Emancipation Day in the District of Columbia on Friday April 15, 2011, taxpayers received extra time to file their 2010 individual income tax returns. The filing deadline moved to Monday, April 18, 2011. By law, holidays in the District of Columbia impact federal tax deadlines.

In other filing season news, some taxpayers experienced delays in the processing of their returns because of tax legislation passed by Congress in late 2010. The IRS needed additional time to program its computer systems for the late legislation. Most programming issues were resolved by mid-February 2011. However, the IRS continued to experience difficulties processing returns claiming the first-time homebuyer tax credit.

Basis overstatement

The Seventh Circuit Court of Appeals held that a six-year statute of limitations applies to overstatements of basis. (Beard, January 26, 2011). The Court of Appeals for the Federal Circuit also ruled in favor of the IRS (Grapevine Imports, Ltd., March 11, 2011). The decisions uphold IRS regulations that specifically apply the six-year limitation period to the assessment of tax attributable to partnership items. The decisions also continue a split among the circuit courts of appeal whether an overstatement of basis is an omission of gross income for purposes of the Code Sec. 6501(e) six-year limitations period. In February, two other courts of appeal ruled against the IRS. The Fourth Circuit Court of Appeals (in Home Concrete & Supply, February 7, 2011) and the Fifth Circuit Court of Appeals (in Burks, February 9, 2011) found that an overstatement of basis is not an omission of gross income.

Vehicle depreciation

The IRS issued limitations on depreciation deductions for owners of passenger cars and trucks and vans first placed in service in calendar year 2011. The IRS also provided revised tables of depreciation limitations for vehicles first placed in service (or first leased by the taxpayer) during 2010 to which bonus depreciation applies.

Offshore accounts

The IRS announced a second offshore voluntary compliance initiative in February. The 2011 initiative is similar to one offered to taxpayers in 2009 but with a different penalty framework. The initiative is scheduled to run through August 31, 2011 and is designed to encourage taxpayers to disclose unreported offshore accounts. Generally, taxpayers must pay a penalty of 25 percent of the amount in the foreign bank account with the highest aggregate account balance covering the 2003 to 2010 period. Some taxpayers may be eligible for reduced penalties of 12.5 percent (generally taxpayers whose offshore accounts did not surpass $75,000 in any calendar ear covered by the initiative) or five percent (generally taxpayers who meet very narrow criteria, including but not limited to, infrequent and minimal contact with the foreign account).

In related news, the Treasury Department issued final rules on the filing of Form TD-F 90-22.1 (Report of Foreign Bank and Financial Accounts), known as “FBAR.” The Bank Secrecy Act requires each United States person to file an FBAR if the person has a financial interest in, or signature authority over, one or more accounts in a foreign country and the aggregate value of those accounts exceeds $10,000 at any time during the calendar year.

IRS liens

The IRS announced new measures to help taxpayers struggling during the economic slowdown. The agency is revising its lien processes, making changes to installment agreements for small businesses, and expanding a streamlined offer in compromise (OIC) program. Among other changes, liens can now be withdrawn immediately once full payment of taxes is made if the taxpayer so requests. The IRS also announced it will increase the dollar thresholds when liens are generally filed. Streamlined installment agreements will be made available to more small businesses.

Flexible spending arrangements

Health care reform legislation enacted in 2010 made some important changes to flexible spending arrangements (FSAs). Beginning January 1, 2011, the costs of over-the-counter (OTC) medications and drugs may be reimbursed under an FSA only if the medications and drugs are purchased with a prescription (subject some exceptions). Previously, taxpayers could use FSA dollars to purchase OTC medications and drugs without a prescription. The IRS issued guidance on the use of FSA debit cards for prescribed OTC medications and drugs early in 2011.

Gift cards

As store gifts cards have grown in popularity, so have questions about accounting for gift cards and tax treatment. The IRS answered some of those questions in new guidance. Revenue Procedure 2011-17 provides a safe harbor method of accounting for accrual method merchants that issue gift cards to customers in exchange for returned merchandise. Revenue Procedure 2011-18 allows taxpayers to defer recognizing in gross income advance payments received from the sale of gift cards that are redeemable for goods or services of the taxpayer or a third party.

IRS regulations

Every year, the IRS issues regulations to implement the provisions in the Tax Code. Sometimes, taxpayers challenge the IRS regulations as exceeding the agency’s authority or for other reasons. In January, the U.S. Supreme Court held that IRS regulations are entitled to a high level of deference (Mayo Foundation, S. Ct., January 11, 2011). The Supreme Court’s decision may make it more difficult for taxpayers to challenge IRS regulations.

Innocent spouse relief

In January, the Third Circuit Court of Appeals upheld a two-year deadline for seeking equitable innocent spouse relief (Mannella, January 19, 2011). The Third Circuit found that the IRS regulations, which set a two-year deadline, are reasonable. However, some courts have found that the IRS regulations are not reasonable. The dispute may one day be decided by the U.S. Supreme Court.

Exempt organizations

The IRS announced that more small tax-exempt organizations would be eligible to file a simplified annual information return. For tax years beginning on or after January 1, 2010, tax-exempt organizations with annual gross receipts of $50,000 or less can file Form 990-N, Electronic Notification e-Postcard. The threshold previously was $25,000 in annual gross receipts.

Health care reform

Several federal district courts weighed-in on the constitutionality of health care reform legislation enacted in 2010. A federal district court in Mississippi rejected a constitutional challenge to the legislation (Bryant, DC-Miss., February 2, 2011). However, federal district courts in Florida and Virginia found that the health care reform legislation was unconstitutional (Florida, DC-Fla., January 31, 2011, Sebelius, DC-Va., December 13, 2010). The Third Circuit Court of Appeals is expected to be the first appellate court to rule on the constitutionality of health care reform. The Third Circuit has scheduled a hearing on the Virginia case in May.

These are just some of the many federal tax developments during the first quarter of 2011. Please contact our office if you have any questions about these or any tax developments.

 

 

Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

New Tax Reporting Requirements for Landlords

March 23, 2011


While January 1, 2011 ushers in a new year for all, it also brings with it new reporting requirements for landlords. New law enacted as part of the Small Business Jobs Act of 2010 (2010 Small Business Jobs Act), landlords receiving rental income from real property will be required to file information returns with the IRS, generally a Form 1099-MISC, when they pay any contractor or other service provider $600 or more during the year for rental property expenses.

Information returns. An information return is generally required, under Tax Code Section 6041(a), to be made by a person (the payor) engaged in a trade or business that makes certain payments aggregating $600 or more in any tax year to another person (payee) in the course of the payor’s trade or business. This filing requirement is commonly known as the “$600-or-more” rule. The information return must be filed with the IRS and corresponding statements must be sent to each payee. Form 1099-MISC, Miscellaneous Income, is generally used for this purpose.

New reporting requirement. Under the 2010 Small Business Act, a person receiving rental income from real estate is automatically considered to be engaged in a trade or business of renting property for information reporting purposes and is now subject to the “$600 or more” reporting requirement. The new reporting requirement, effective for payments made after December 31, 2010, applies to landlords who make payments to plumbers and other maintenance individuals and service providers, landscaping services, accountants, and many other service providers (subject to some exceptions; for example, attorneys). The first information returns from landlords required under this new provision, therefore, will be due January 2012 for 2011 payments.

The $600-or-more amount is an amount aggregated throughout the year, meaning that if pay a particular service provider amounts that together total $600 or more for their services throughout the year, you are subject to the reporting requirement.

Example. You are the landlord of a 25-unit apartment complex downtown. You have a landscaping service come every two weeks to trim the bushes, cut tree branches, and mow the grass outside of the complex. They charge $200 per visit. Since your payments to them during the year will total well over $600, you will be required to provide the IRS a Form 1099 reporting the payments you make, as well as furnish the landscaping company with a copy.

Exceptions. The new reporting rule does not apply to individuals who only receive rental income of only a minimal amount. The IRS has been given the authority to define “a minimal amount” as the term is used under the new law but has not yet done so. Small landlords and their advisors are lobbying for a high amount out of concern over the undue burdens placed on many landlords as the result of this new requirement.

The new reporting requirement also does not apply to any individual, including individuals who are active members of the uniformed services or an employee of the intelligence community, if substantially all rental income they derive is from renting their principal residence on a temporary basis. The new reporting requirement also does not apply if it would cause a hardship to the individual. The IRS will determine what a “hardship” is for purposes of this exception.

Nevertheless, beginning this year if you receive rental income from real property and make payments of $600 or more to any service provider who is not incorporated, and one of the above-mentioned exceptions does not apply, you will be required to report these rental property expenses to the IRS. You will also be required to furnish a copy of the Form 1099-MISC to the service provider.

Penalties. Failing to comply with the new reporting requirements may result in the imposition of penalties, which may include a penalty for failure to file the information return; a penalty for failure to furnish payee statements to the service provider; or a penalty for failure to comply with other various reporting requirements.

To more easily comply with the new requirements, if you have not already, you may want to implement new recordkeeping systems and maintain a database with the names, addresses, taxpayer identification numbers (TINs) or employer identification numbers (EINs), and other pertinent information, including payments and amount made to each throughout the year of your service providers. You will have to provide the IRS with the TIN or EIN of the service providers you engage. Maintaining these records also will help you prove the legitimate deductibility of these expenses from the rental income on which you otherwise need to pay income tax.

If you have any questions about these new reporting requirements, please contact our office.

Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

What’s New for Tax Season 2011

January 5, 2011

The Internal Revenue Service today opened the 2011 tax filing season by announcing that taxpayers have until April 18 to file their tax returns.

Taxpayers will have until Monday, April 18 to file their 2010 tax returns and pay any tax due because Emancipation Day, a holiday observed in the District of Columbia, falls this year on Friday, April 15. By law, District of Columbia holidays impact tax deadlines in the same way that federal holidays do; therefore, all taxpayers will have three extra days to file this year. Taxpayers requesting an extension will have until Oct. 17 to file their 2010 tax returns.

For most taxpayers, the 2011 tax filing season starts on schedule. However, tax law changes enacted by Congress and signed by President Obama in December mean some people need to wait until mid- to late February to file their tax returns in order to give the IRS time to reprogram its processing systems.

Some taxpayers – including those who itemize deductions on Form 1040 Schedule A – will need to wait to file. This includes taxpayers impacted by any of three tax provisions that expired at the end of 2009 and were renewed by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act Of 2010 enacted Dec. 17. Those who need to wait to file include:

  • Taxpayers Claiming Itemized Deductions on Schedule A. Itemized deductions include mortgage interest, charitable deductions, medical and dental expenses as well as state and local taxes. In addition, itemized deductions include the state and local general sales tax deduction that was also extended and which primarily benefits people living in areas without state and local income taxes. Because of late Congressional action to enact tax law changes, anyone who itemizes and files a Schedule A will need to wait to file until mid- to late February.
  • Taxpayers Claiming the Higher Education Tuition and Fees Deduction. This deduction for parents and students – covering up to $4,000 of tuition and fees paid to a post-secondary institution – is claimed on Form 8917. However, the IRS emphasized that there will be no delays for millions of parents and students who claim other education credits, including the American Opportunity Tax Credit extended last month and the Lifetime Learning Credit.
  • Taxpayers Claiming the Educator Expense Deduction. This deduction is for kindergarten through grade 12 educators with out-of-pocket classroom expenses of up to $250. The educator expense deduction is claimed on Form 1040, Line 23 and Form 1040A, Line 16.

In addition to extending those tax deductions for 2010, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act also extended those deductions for 2011 and a number of other tax deductions and credits for 2011 and 2012 such as the American Opportunity Tax Credit and the modified Child Tax Credit, which help families pay for college and other child-related expenses. The Act also provides various job creation and investment incentives including 100 percent expensing and a two-percent payroll tax reduction for 2011. Those changes have no effect on the 2011 filing season.

The IRS will announce a specific date in the near future when it can start processing tax returns impacted by the recent tax law changes. In the interim, taxpayers affected by these tax law changes can start working on their tax returns, but they should not submit their returns until IRS systems are ready to process the new tax law changes. Additional information will be available at www.IRS.gov.

For taxpayers who must wait before filing, the delay affects both paper filers and electronic filers.

Except for those facing a delay, the IRS will begin accepting e-file and Free File returns on Jan. 14. Additional details about e-file and Free File will be announced later this month.

2010 Tax Relief Act

December 31, 2010

After weeks of intense negotiations between the White House and Congressional leaders, Congress passed and President Obama signed into law a two-year extension of soon-to-have-expired Bush-era tax cuts, including extension of current individual tax rates and capital gains/dividend tax rates. Called the most sweeping tax law in a decade, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (H.R. 4853), was approved by the Senate on December 15, 2010 and by the House on December 16, 2010. The new law is, however, much more than just an extension of existing tax rates. The new law also provides a temporary across-the-board payroll tax cut for wage earners, a retroactive AMT “patch,” estate tax relief, education and energy incentives and many valuable incentives for businesses, including 100 percent bonus depreciation and extension of many temporary tax breaks. This letter highlights many of the key incentives in the new law. As always, please call or email our office for more details.
Individuals
Tax rates. Among the most valuable tax breaks for individuals in the new law are a two-year extension of individual income tax rate reductions and a payroll tax cut. Both will deliver immediate tax savings starting in January 2011. The new law keeps in place the current 10, 15, 25, 28, 33, and 35 percent individual tax rates for two years, through December 31, 2012. If Congress had not passed this extension, the individual tax rates would have jumped significantly for all income levels. The new law also extends full repeal of the limitation on itemized deductions and the personal exemption phaseout for two years. Married couples filing jointly will also benefit from extended provisions designed to ameliorate the so-called marriage penalty.
Payroll tax cut. The payroll tax cut is designed to get more money into workers’ paychecks and to encourage consumer spending. Effective for calendar year 2011, the employee share of the OASDI portion of Social Security taxes is reduced from 6.2 percent to 4.2 percent up to the taxable wage base of $106,800. Self-employed individuals also benefit. Self-employed individuals will pay 10.4 percent on self-employment income up to the wage base (reduced from the normal 12.4 percent rate). The payroll cut replaces the Making Work Pay credit, which reduced income tax withholding for wage earners in 2009 and 2010. The payroll tax cut, unlike the credit, does not exclude some individuals based on their earnings and has the potential of significantly higher benefits (with a maximum payroll tax reduction of $2,136 on wages at or above the $106,800 level as compared to a maximum available $800 Making Work Pay credit for married couples filing jointly ($400 for single individuals)).
Capital gains/dividends. The new law also extends reduced capital gains and dividend tax rates. Like the individual rate cuts, the extended capital gains and dividend tax rates are temporary and will expire after 2012 unless Congress intervenes. In the meantime, however, for two years (2011 and 2012), individuals in the 10 and 15 percent rate brackets can take advantage of a zero percent capital gains and dividend tax rate. Individuals in higher rate brackets will enjoy a maximum tax rate of 15 percent on capital gains, as opposed to a 20 percent rate that had been scheduled to replace it and with dividends taxed at income tax rates. Only net capital gains and qualified dividends are eligible for this special tax treatment. If you have any questions about your capital gain/dividend income, please contact our office.
AMT patch. More and more individuals are finding themselves falling under the alternative minimum tax (AMT) because of the way the AMT is structured. To prevent the AMT from encroaching on middle income taxpayers, Congress has routinely enacted so-called “AMT patches.” The new law continues this trend by providing higher exemption amounts and other targeted relief.
More incentives. Along with all these incentives, the new law extends many popular but temporary tax breaks. Extended for 2011 and 2012 are:
$1,000 child tax credit
Enhanced earned income tax credit
Adoption credit with modifications
Dependent care credit
Deduction for certain mortgage insurance premiums
The new law also extends retroactively some other valuable tax incentives for individuals that expired at the end of 2009. These incentives are extended for 2010 and 2011 and include:
State and local sales tax deduction
Teacher’s classroom expense deduction
Charitable contributions of IRA proceeds
Charitable contributions of appreciated property for conservation purposes
Businesses
Bonus depreciation. Bonus depreciation is intended to help businesses depreciate purchases faster against their taxable income, thereby encouraging businesses to invest in more equipment. Bonus depreciation allows businesses to recover the costs of certain capital expenditures more quickly than under ordinary tax depreciation schedules. Businesses can use bonus depreciation to immediately write off a percentage of the cost of depreciable property. The new law makes 100 percent bonus depreciation available for qualified investments made after September 8, 2010 and before January 1, 2012. It also continues bonus depreciation, albeit at 50 percent, on property placed in service after December 31, 2011 and before January 1, 2013. There are special rules for certain longer-lived and transportation property. Additionally, certain taxpayers may claim refundable credits in lieu of bonus depreciation. 100 percent bonus depreciation is a valuable tax break and businesses have only a short window to take advantage of it. Please contact our office so we can help you plan for 100 bonus depreciation.
Code Sec. 179 expensing. Along with bonus depreciation, the new law also provides for enhanced Code Sec. 179 expensing for 2012. Under current law, the Code Sec. 179 dollar and investment limits are $500,000 and $2 million, respectively, for tax years beginning in 2010 and 2011. The new law provides for a $125,000 dollar limit (indexed for inflation) and a $500,000 investment limit (indexed for inflation) for tax years beginning in 2012 (but not after).
Research credit. Many businesses urged Congress to make the research credit permanent after the credit expired at the end of 2009. While this proposal enjoyed significant support in Congress, its cost was deemed prohibitive. Instead, Congress extended the research tax credit for two years, for 2010 and 2011.
More incentives. Other valuable business incentives in the new law include extensions of:
100 percent exclusion of gain from qualified small business stock
Transit benefits parity
Work Opportunity Tax Credit (with modifications)
New Markets Tax Credit (with modifications)
Differential wage credit
Brownfields remediation
Active financing exception/look-through treatment for CFCs
Tax incentives for empowerment zones
Special rules for charitable deductions by corporations and other businesses
And more
Energy
In 2010, Congress had been expected to pass comprehensive energy legislation including new and enhanced tax incentives. For a number of reasons, an energy bill did not pass. However, the new law extends some energy tax breaks for businesses. The new law also extends, but modifies, a popular energy tax break for individuals.
Businesses. For businesses, one of the most valuable energy incentives is the Code Sec. 1603 cash grant in lieu of a tax credit program. This incentive encourages the development of alternative energy sources, such as wind energy. Other business energy incentives extended by the new law include excise tax and other credits for alternative fuels, percentage depletion for oil and gas from marginal wells, and other targeted incentives.
Individuals. Individuals who made energy efficiency improvements to their homes in 2009 or 2010 are likely familiar with the Code Sec. 25C energy tax credit. This credit rewards individuals who install energy efficient furnaces or add insulation, or make other improvements to reduce energy usage. The new law extends the credit through 2011 but reduces some of its benefits. Although 2010 is soon over, there may still be time to take advantage of the more generous credit. Please contact our office.
Education
The Tax Code includes a number of incentives to encourage individuals to save for education expenses. In 2009, Congress enhanced the Hope education credit and renamed it the American Opportunity Tax Credit (AOTC). Like many other incentives, the AOTC was temporary. The new law extends it for two years, through 2012. Along with the AOTC, the new law also extends:
Higher education tuition deduction
Student loan interest deduction
Exclusion for employer-provided educational assistance
Enhanced Coverdell education savings accounts
Special rules for certain scholarships
Estate and gift taxes
The federal estate tax, along with federal gift and generation skipping transfer (GST) taxes, was significantly overhauled in 2001. At that time, Congress set in motion a gradual reduction of the estate tax until abolishing it for 2010. Under budget rules, however, those changes could extend for only 10 years; starting in 2011, the estate tax had been scheduled to revert to its pre-2001 levels of 55 percent and a $1 million exclusion.
Estate tax. The new law revives the estate tax, but with a maximum estate tax rate of 35 percent with a $5 million exclusion. The revived estate tax is in place for decedents dying in 2011 and 2012. The new law gives estates the option to elect to apply the estate tax at the 35 percent/$5 million levels for 2010 or to apply carryover basis for 2010. The new law also allows “portability” between spouses of the maximum exclusion and extends some other taxpayer-friendly provisions originally enacted in 2001.
This far-reaching multi-billion dollar tax package affects almost every taxpayer. Keep in mind that many of its provisions are temporary. It is important to plan early to maximize your tax savings. Please contact our office if you have any questions.

Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

Starting a Business – Pros and Cons of S Corporations

December 3, 2010


Especially popular among small businesses, the number of S corporations has quadrupled in the past 15 years and, hands down, is the most common form of doing business except for the unincorporated sole proprietorship. While its popularity indicates that consideration of operating your business as an S corporation is certainly wise, “going with the crowd” is not always the best choice. What is right for your business and your unique circumstances should control.

Some of the advantages of operating a business as an S corporation are:
1. Your personal assets will not be at risk because of the activities or liabilities of the S corporation (unless, of course, you pledge assets or personally guarantee the corporation’s debt).
2. Your S corporation generally will not have to pay corporate level income tax. Instead, the corporation’s gains, losses, deductions, and credits are passed through to you and any other shareholders, and are claimed on your individual returns. The fact that losses can be claimed on the shareholders’ individual returns (subject to what are known as the passive loss limits — S corps pay tax at the highest corporate rate on their excess passive income) can be a big advantage over regular corporations. Liquidating distributions generally also are subject to only one level.
3. The S corporation has no corporate alternative minimum tax (AMT) liability (however, corporate items passed through to you may affect your individual AMT liability).
4. FICA tax is not owed on the regular business earnings of the corporation, only on salaries paid to employees. This is a potential advantage over sole proprietorships, partnerships, and limited liability companies.
5. The S corporation is not subject to the so-called accumulated earnings tax that applies to regular corporations that do not distribute their earnings and have no plan for their use by the corporation. Nor because of their pass-through nature do they risk being characterized as a personal holding company.

Some of the disadvantages are:
1. S corporations cannot have more than 100 shareholders (but with husband and wife being considered as only one shareholder). Further, no shareholder may be a nonresident alien.
2. Corporations, nonresident aliens, and most estates and trusts cannot be S corporation shareholders. Electing small business trusts, however, can be shareholders, a distinct estate planning advantage.
3. S corporations may not own subsidiaries, which can make expansion difficult, unless the subsidiary is a Qualified Subchapter S Subsidiary (a 100% owned S corporation or QSub); and termination of the QSub’s status can be treated as a sale of assets.
4. S corporations can have only one class of stock (although differences in voting rights are permitted). This severely limits how income and losses of the corporation can be allocated among shareholders. It also can impair the corporation’s ability to raise capital. However, the Small Business and Work Opportunity Tax Act of 2007 eliminated the treatment of bank director stock as a second class of stock.
5. A shareholder’s basis in the corporation does not include any of the corporation’s debt, even if the shareholder has personally guaranteed it. This has the effect of limiting the amount of losses that can be passed through. It is a disadvantage compared to partnerships and limited liability companies, and is one of the main reasons that those forms are usually used for real estate ventures and other highly-leveraged enterprises.
6. S corporation shareholder-employees with more than a 2-percent ownership interest are not entitled to most tax-favored fringe benefits that are available to employees or regular corporations.
7. S corporations generally must operate on a calendar year.
8. An S corporation may be liable for a tax on its built-in gains, if, among other things, it was a C corporation prior to making its S corporation election. Under the American Recovery and Reinvestment Act of 2009, no tax will be imposed on an S corporation’s net recognized built-in gain if the seventh tax year in the 10-year recognition period preceded the tax year for a tax year in 2009 or 2010. Under the Small Business Jobs Act of 2010, Congress shortened the holding period even further, to five years, in the case of any tax year beginning in 2011, if the fifth year in the recognition period precedes the tax year beginning in 2011.

Some of these factors will be more important than others, depending upon the particular circumstances. If you would like to pursue this matter further, and have us fully evaluate your situation, please do not hesitate to call.

Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

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