Doeren Mayhew: The production deduction

After a series of adverse rulings by the World Trade Organization (WTO), Congress curtailed its efforts to benefit exporters and instead provided a tax deduction for all manufacturers — whether they export or not.

The American Jobs Creation Act of 2004 (AJCA) repealed the extraterritorial income (ETI) exclusion and established the manufacturers’ deduction — also commonly referred to as the Section 199 or domestic production activities deduction. And the deduction isn’t just for traditional manufacturers. It’s also available to eligible construction contractors, engineers, architects, software developers, film producers, energy producers, farmers and agricultural processors. After a five-year phase-in period, the deduction reaches its maximum amount in 2010.

How the deduction works

The manufacturers’ deduction permits eligible taxpayers to deduct a specified percentage of the lesser of: 1) their income from “qualified production activities,” or 2) their taxable income for the year. The deduction may not exceed 50% of the W-2 wages a taxpayer pays during the year. Wages not allocable to domestic production gross receipts are excluded from W-2 wages for the purposes of the deduction.

The specified percentage phased in from 2005 through 2009 and reaches its maximum amount in 2010,  going up from 6% in 2009 to 9% in 2010 and thereafter. As a result, in 2010 the deduction will lower the maximum effective marginal tax rate on qualifying income from 35% to 31.85%.

Qualified income is calculated by taking gross receipts from domestic production and subtracting the cost of goods sold and other allocable costs, deductions, expenses and losses. Domestic production gross receipts are those derived from any lease, rental, license, sale, exchange or other disposition of:

• Qualifying production property (including tangible personal property, computer software and certain sound recordings) manufactured, produced, grown or extracted by the taxpayer in whole or in significant part in the United States,

• Qualified films produced by the taxpayer, or

• Electricity, natural gas or potable water produced by the taxpayer in the United States.

Domestic production gross receipts also include receipts from construction and engineering or architectural services performed in the United States.

Two significant exceptions are receipts from the sale of food and beverages prepared by taxpayers at retail establishments and the transmission or distribution of electricity, natural gas and potable water.

Additionally, the deduction isn’t allowed in determining net earnings from self-employment and generally can’t reduce net income below zero. But it can be used against the alternative minimum tax (AMT).

Looking more closely

The manufacturers’ deduction provides many companies with a potentially significant tax break. But the rules are complex, so be sure to take a closer look at whether you might qualify and what you need to do to maximize your tax savings.

Should the reader have any questions regarding any of the content contained within this article, it is recommended that a Doeren Mayhew representative be contacted.

Doeren Mayhew: Still sitting on the fence?

Picking the best retirement plan for your business

It’s common business knowledge that the key to getting, and keeping, good employees is to offer a benefit package they’ll appreciate. But you also want to make sure that you — as the owner — get all the tax breaks you’re entitled to.

A retirement plan is a good place to start. Whether yours is a new business just starting out or an existing business now ready to set up a plan, many of the considerations are the same.

Not one-size-fits-all

Retirement plans aren’t a one-size-fits-all proposition. Most small to midsize businesses implement 401(k) plans, Savings Incentive Match Plans for Employees (SIMPLEs), and Simplified Employee Pension (SEP) IRAs for their employees. Regardless of the plan, employer contributions are deductible, employee contributions are pretax and plan funds grow tax-deferred.

To determine which plan is best for your business, you’ll need to consider a variety of factors. Tax treatment and contribution limits are obvious concerns. But other factors also matter: company size and employee limits, employee age and turnover, employee compensation and company profits, flexibility of contribution amounts, treatment for owners and other highly compensated employees, reporting requirements, and administrative costs.

401(k) plans top the list

401(k)s are by far the most popular form of retirement plan. They are contributory plans — meaning the employee makes contributions through redirected salary. You can choose to match the employee’s contribution, up to certain limits.

401(k)s have a higher employee contribution limit than either SIMPLEs or SEP-IRAs — for 2010, contribution limits are $16,500, plus $5,500 for the age 50 and over catch-up amount.

Although the 401(k) has the advantage of higher employee contribution limits, it also has the most reporting requirements, making it more costly to create and maintain. Because annual requirements include filing a tax return (Form 5500) and compliance testing, most businesses turn over plan administration to an outside professional.

Employees are always 100% vested in their contributions to their account. Although amounts redirected to a 401(k) aren’t currently subject to income tax, the earnings are subject to FICA and Medicare tax.

You have some flexibility in determining whether to match your employees’ contributions. Employer contributions can vest over time, based on plan schedules. If the plan is top-heavy (favoring highly compensated employees), employer contribution matching and vesting become subject to IRS requirements. To maximize your own contributions — as the owner — you’ll need to monitor and encourage employee contributions, perhaps by providing an employer match.

Roths may be the way to go

If your plan is set up to accommodate a Roth 401(k), participants in a 401(k) or 403(b) plan may designate some, or all, of their elective contributions as a Roth contribution. Roth contributions will be taxed (not tax-deferred as in a traditional 401(k)), but all qualified withdrawals will be tax free, which means participants may never have to pay tax on growth in the plans. Plus, there are no required distributions.

To have a qualifying Roth contribution program, your retirement plan must establish a separate designated Roth account for each employee and maintain separate recordkeeping for each account.

SIMPLEs not just a runner-up

There are two types of SIMPLEs: a SIMPLE IRA and a SIMPLE 401(k). Both are contributory plans allowing employee contributions for 2010 of up to $11,500, indexed for inflation, and an additional $2,500 for employees age 50 and older.

With a SIMPLE, you’re required to match employee contributions up to 3% of pay, or you can choose to contribute 2% of pay for each employee. This matching is mandatory, unlike with the traditional 401(k). All contributions vest immediately.

SIMPLEs have a major advantage over 401(k)s in that they are, in fact, simple. With no annual tax return filing, and minimal documentation requirements, SIMPLEs are easier to handle, and you may avoid administration fees altogether. However, due to their lower contribution limit, SIMPLE plans may not be a good choice for owners who are seeking to maximize their retirement plan contributions.

SEP-IRAs funded entirely by employer

Unlike the SIMPLE and 401(k) plans, the SEP-IRA is a noncontributory plan — meaning no employee contributions are allowed. The SEP-IRA is entirely funded by employer contributions. Contributions are discretionary, but can’t exceed a specified limit — 25% of an eligible employee’s compensation up to a maximum of $49,000 in 2010. Participants are immediately vested.

SEP-IRAs are easy and inexpensive to set up and administer. No annual tax return is required, and you have until the due date of the company tax return (including extensions) to make your contribution. The company must include all eligible employees, but, because employer contributions are optional, contributions can be lower (or skipped) in a year in which your company is strapped for cash.

A business owner who’s self-employed, or employs primarily family members, may find that a SEP-IRA provides significant retirement funding benefits. When there are other employees who must be covered, the employer contribution may be viewed as too expensive.

You may get a credit for plan startup

If you’re ready to take the plunge and implement a retirement plan, Uncle Sam may help with some of the costs. Small employers — those with 100 or fewer employees — may be eligible for a credit of up to 50% of the first $1,000 spent on retirement plan administration and education for employees. This credit is available for the first three years of the plan — amounting to a maximum of $500 credit for each year.

We’ve covered only a few retirement plans. Other possibilities include defined benefit plans and other profit sharing or defined contribution plans. The greatest benefits may result from a mix-and-match approach. Combining plans could increase the allowable contributions for owners. You may also want to evaluate nonqualified deferred compensation arrangements to meet your retirement funding goals.

 Should the reader have any questions regarding any of the content contained within this article, it is recommended that a Doeren Mayhew representative be contacted.

Congress faces historic tax law decisions in fall session

Congress returns to work in mid-September to a full agenda of tax legislation, dominated by the fast-approaching expiration of the 2001 individual marginal income tax rate reductions. Predicting when Congress will act on the rate cuts or any legislation is nearly impossible. House Democrats, who have already passed a number of tax bills, appear to be allowing the Senate to take the lead in the weeks preceding the November elections. The uncertainty over the fate of many tax provisions makes year-end tax planning more important than ever.




Individual tax rates



For many taxpayers, the greatest uncertainty is over the fate of the 2001 individual income tax rate reductions. After December 31, 2010, the individual marginal income tax rates for all taxpayers will rise when the reduced rates expire. President Obama has asked Congress to extend all of the 2001 individual marginal income tax reductions except for the top two rates.



Change is coming regardless of whether Congress approves the president's proposal or allows the reduced rates to expire entirely. The likely prospect of higher income tax rates significantly impacts tax planning for individuals and business owners.



Individuals may benefit from many traditional planning techniques. Individuals expecting to be in a higher tax rate in a future year because of higher income levels may want take into account the timing of income or deductible expenses in one tax year or another. An individual may find that accelerating income into 2010, so it is taxed at a lower rate, may be advantageous. You may be able to accelerate payments due to you. Another strategy may be to take withdrawals from retirement savings, either as part of a Roth IRA conversion plan or otherwise, to accelerate income into 2010. Similarly, deferring deductions into 2011 may help offset income that is expected to be taxed at a higher rate. You may consider holding off on a charitable contribution until 2011. Our office can help you design a strategy that works best for you.



Individuals in the highest tax brackets also should consider the likely reinstatement of the limitation on itemized deductions. For 2010 - and 2010 only - the limitation on itemized deductions for higher income taxpayers is completely repealed. The provision limits the total amount of otherwise allowable itemized deductions for higher income taxpayers. President Obama has asked Congress to allow the limitation on itemized deductions to return but to modify it for 2011 and beyond.



Capital gains/dividends



Also expiring after December 31, 2010 are reduced capital gains and dividends tax rates. For 2010, the maximum capital gains and dividends tax rate is 15 percent (zero percent for taxpayers in the 10 and 15 percent brackets). President Obama has asked Congress to impose a 20 percent capital gains and dividends tax rate on higher-income individuals for 2011 and beyond. All other taxpayers would pay capital gains and dividends taxes of 15 percent unless they qualify for the zero percent tax rate. Generally, the 20 percent tax rate would apply to individuals with incomes over $200,000 and married couples filing a joint return with incomes over $250,000.



Small business



The House and Senate have tried several times this year to send a small business tax relief bill to the White House but have failed. House-passed bills stalled in the Senate. The stalemate in the Senate may break this fall because lawmakers are eager to show voters they support "jobs" bills.



Some of the small business tax relief measures that enjoy bipartisan support are:



--Expansion of the small business stock exclusion to 100 percent; --Reform of the Code Sec. 6707A penalties for reportable transactions; --An increase in the deduction for qualified start-up expenses; --Enhanced Code Sec. 179 expensing; and --Bonus depreciation.



Homebuyers



The popular first-time homebuyer tax credit (and the reduced credit for long-time residents) has expired. The credit was popular because Congress made it fully refundable and certain lenders allowed purchasers to monetize the credit toward a down payment. Recent reports about sales of new homes reaching record lows may encourage Congress to consider extending the incentive. However, Congress must find a way to pay for the credit if it decides to extend it.



Estate tax



Nine years ago, Congress repealed the federal estate tax. Because of budget concerns, Congress delayed full repeal until 2010. For individuals dying in 2010, the traditional stepped-up basis rules are replaced with a modified carryover basis regime. Again, because of budget concerns, full repeal expires after December 31, 2010. If Congress takes no action on the estate tax before year-end, the exemption level will be $1 million in 2011 and the maximum estate tax rate will be 55 percent.



The House has approved legislation to make permanent the estate tax rules as they were in 2009. The House bill has languished in the Senate over not only its cost but also concerns over whether to make it retroactive to January 1, 2010. Some states have already passed bills to protect older wills based on formula dispositions, which may not have anticipated repeal of the estate tax in 2010.



Extenders



A package of tax extenders has stalled in the Senate and is unlikely to pass as a single bill because of its price tag. Instead, Democratic leaders in the Senate have indicated that they may enact some of the extenders in other bills, especially the extenders that have support from both parties. House Democrats would prefer the Senate keep the extenders in one bill but will likely acquiesce in enacting some of the extenders rather than none.



Among the extenders that enjoy bipartisan support are:



--Research tax credit; --State and local sales tax deduction; --Teachers' classroom expense deduction; --Higher education tuition deduction; and --Energy incentives for consumers.



Offsets



Congress must find offsets to pay for any tax cuts and its options are dwindling. Two House-approved revenue raisers, a change in the tax treatment of carried interest and the imposition of self-employment taxes on service S corps, died in the Senate and are unlikely to be revived. Less controversial are reforms to grantor retained annuity trusts (GRATs) and the cellulosic biofuel credit. Congress could also abolish the Code Sec. 199 production activities deduction and raise taxes on oil and gas producers.



Lawmakers have a short window in which to try to pass critical tax bills before year-end. Our office will keep you posted of developments. Please contact our office if you have any questions.
 

Should the reader have any questions regarding any of the content contained within this article, it is recommended that a representative from Doeren Mayhew be contacted

Don’t make a tax mess when paying household employees

Millions of American families hire people to work in their homes, such as nannies, housekeepers, cooks, gardeners and health care workers. If you employ domestic workers, be sure you understand the tax rules — it can pay off for you and your employees.




Household employee qualifications



Not everyone who works at your home is considered a household employee for tax purposes. To understand your obligations, determine whether your workers are employees or independent contractors. Independent contractors are responsible for their own employment taxes, while household employers and employees share the responsibility.



Workers are generally considered employees if you control what they do and how they do it. It makes no difference whether you employ them full time or part time, or pay them a salary or an hourly wage.



Let’s say, for example, you hire a nanny to care for your child and do light housework 30 hours a week. She performs her duties according to your instructions and uses your supplies. The nanny is considered a household employee.



On the other hand, suppose you hire a gardener to mow your lawn and provide other landscaping services twice a month. Because he furnishes his own equipment and supplies, pays other workers as needed, sets his own schedule and offers his services to others, the gardener is classified as an independent contractor.



Social Security and Medicare taxes



If a household worker’s cash wages exceed the domestic employee coverage threshold of $1,700 in 2010, you must pay Social Security and Medicare taxes —15.3% of cash wages, which you can pay entirely or split with the worker. (If you and the worker share the expense, you must withhold his or her share.)



But don’t count wages you pay to:



• Your spouse,



• Your children under age 21,



• Your parents (with some exceptions), and



• Household workers under age 18 (unless working for you is their principal occupation).



The domestic employee coverage threshold is adjusted annually for inflation, and there’s a wage limit on Social Security tax ($106,800 for 2010, adjusted annually for inflation).



Social Security and Medicare taxes apply only to cash wages, which don’t include the value of food, clothing, lodging and other noncash benefits you provide to household employees. You can also exclude reimbursements to employees for certain parking or commuting costs. One way to provide a valuable benefit to household workers while minimizing employment taxes is to provide them with health insurance.



Unemployment and federal income taxes



If you pay total cash wages to household employees of $1,000 or more in any calendar quarter in the current or preceding calendar year, you must pay federal unemployment tax (FUTA). Wages you pay to your spouse, children under age 21 and parents are excluded.



The tax is 6.2% of each household employee’s cash wages up to $7,000 per year. You may also owe state unemployment contributions, but you’re entitled to a FUTA credit for those contributions, up to 5.4% of wages.



You don’t have to withhold federal income tax — or, usually, state income tax — unless the worker requests it and you agree. In these instances, you must withhold federal income taxes on both cash and noncash wages, except for meals you provide employees for your convenience, lodging you provide in your home for your convenience and as a condition of employment, and certain reimbursed commuting and parking costs (including transit passes, tokens, fare cards, qualifying vanpool transportation and qualified parking at or near the workplace).



Tax payment



You can pay federal employment taxes, including amounts withheld from employees’ wages, by filing Schedule H, Household Employment Taxes, with your Form 1040. You may also submit payroll tax forms for your workers (Form 941).



Although you’re not required to make quarterly deposits, you may face penalties unless you cover these amounts. You can do so by making estimated tax payments or increasing withholding from your own paychecks.



If you own a sole proprietorship, you can piggyback household employment taxes onto the deposits or payments you make for your business employees.



Other obligations



As an employer, you have a variety of tax and other legal obligations. This includes obtaining a federal Employer Identification Number (EIN) and having each household employee complete Forms W-4 and I-9, which document that they’re eligible to work in the United States.



After year end, you must also file Form W-2 for each household employee to whom you paid more than $1,700 in Social Security and Medicare wages or for whom you withheld federal income tax. And you must comply with federal and state minimum wage and overtime requirements.



In some states, you may also have to provide workers’ compensation or disability coverage and fulfill other tax, insurance and reporting requirements.



A time saver



Running a household is a lot like running a business. Many companies outsource their tax and other administrative functions so they can concentrate on their core business activities. Similarly, if you have household employees, getting help with your tax responsibilities frees up your time to focus on the things that really matter, such as your loved ones and your work.



Sidebar: A spoonful of compliance …



With many tax and administrative headaches, it’s not surprising that people often pay their household employees “under the table.” But compliance isn’t just the right thing to do; it also offers a number of advantages for both employers and workers.



For starters, you avoid huge penalties and interest — not to mention potential negative publicity. Plus, you may qualify for tax breaks such as flexible spending account reimbursements for child care and the Child and Dependent Care credits. In some cases, these tax savings outweigh the additional tax liability of employment taxes.



Meanwhile, your workers are building an employment history, which helps them qualify for car loans, mortgages and other types of credit. They also benefit from unemployment insurance coverage, Social Security and Medicare benefits, and the Earned Income Tax credit (if eligible).



Should the reader have any questions regarding any of the content contained within this article, it is recommended that a Doeren Mayhew representative be contacted.