Wednesday, July 11, 2012
Supreme Court upholds health care law's individual mandate penalty as a permissible tax
The Supreme Court, in a 5 to 4 decision, has upheld the Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010, the provisions together comprise the Obama health care laws. The landmark decision, handed down on June 28, focused on a key provision of the law - the "individual mandate" - and affirmed that it was constitutional under Congress's taxing power.
The individual mandate requires individuals to purchase health insurance, beginning in 2014, or pay a penalty. Opponents of the law had focused their challenges on the individual mandate, arguing that the mandate was an unconstitutional extension of federal power. The Supreme Court agreed with opponents that the mandate was not authorized by the Constitution's Commerce Clause or Necessary and Proper Clause, because it regulated "inactivity" (the failure to buy health insurance) that was not commerce.
Power to tax
However, although the requirement to buy health insurance was not constitutional, the imposition of a penalty, for failure to purchase insurance, was a permissible extension of Congress's Taxing Power. The court decided that the penalty was a tax, and therefore constitutional under the power to tax, even though the statute labeled the provision a penalty. The court also concluded that Congress's power to impose a tax was less intrusive than its power to regulate interstate commerce and did not exceed the limits of federal authority.
What is a tax?
In determining that the penalty for violating the individual mandate was a tax, the court identified the following factors:
The amount of the payment was small and could never exceed the cost of the insurance itself;
The penalty applied regardless of whether the taxpayer intended to violate the individual mandate (there was no requirement that the individual knowingly break the law);
The only means of collecting the tax was through the IRS, using the usual means to collect a tax. Liens, levies and criminal sanctions were forbidden.
The penalty was the only means for enforcing the mandate. Individuals who chose to pay the penalty, instead of carrying health insurance, would not be breaking the law or risking further punishment.
Interestingly, the court concluded that the Anti-Injunction Act, which limits judicial actions to restrain the collection of a tax, did not apply to the penalty imposed by the individual mandate. In this case, the court determined that the penalty was identified by Congress as a penalty, not a tax, and that this label precluded the application of the Anti-Injunction Act.
Other tax provisions OK
Part of the argument of opponents of the law was that the other provisions in the health care laws were not "severable" from the individual mandate, and that, if the mandate was unconstitutional, the rest of the law was also unconstitutional. The court's upholding of the mandate allows the balance of the health care law to take effect, including its tax provisions. These provisions include the employer's shared responsibility payment, the health insurance premium assistance credit, the small employer premium credit, an additional 0.9 percent Medicare tax on wages and self-employment income, and a 3.8 percent Medicare contribution tax on unearned income. Both of the Medicare taxes apply to higher-income individuals.
Medicaid expansion penalty unconstitutional
The President's health care package did escape with a completely clean bill of health from the Supreme Court. The court did strike down one nontax provision of the law. The law provided the mechanism for an expansion of the Medicaid program that provides health insurance benefits for lower-income individuals and families. Under the law, additional federal payments would be given to states for expanding their state programs. However, if a state failed to implement the expanded program, the law eliminated all federal Medicaid payments, including payments under the state's existing program. The court ruled that "Nothing in our opinion precludes Congress from offering funds under the ACA to expand the availability of health care, and requiring that states accepting such funds comply with the conditions on their use. What Congress is not free to do is to penalize states that choose not to participate in that new program by taking away their existing Medicaid funding."
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.
IRS Oversight Board gives IRS mixed reviews in latest annual report
The IRS Oversight Board delivered its "Annual Report to Congress 2011" on June 5, 2012, as required by law. The latest report highlighted the drop in the IRS's level of service by the IRS toll-free telephone assistors, the continued trend of focusing examination resources on higher income taxpayers, and serious concerns about the effect that IRS budget cuts will have on the agency's strategic goals. The Board concluded that while the IRS has generally met its performance goals and made achievements related to e-filing and online services, the agency is still challenged in its efforts to reduce the tax gap.
Recent IRS achievements
The Board reported several positive developments within the IRS over FY 2011, including: --Launching the first IRS smartphone application, IRS2Go, which enables users to check the status of their tax refunds and access tax tips form their phones; --Increasing significantly the number of individual tax returns filed electronically; --Stopping $14.4 billion in fraudulently claimed tax refunds; and --Implementing the Preparer Tax Identification Number (PTIN) system.
E-filing. The Board reported that the number of individual tax returns filed electronically had increased by 13 percent, from 98.3 million e-filed returns in 2010 to 111 million in 2011. The overall e-filing rates for individual returns are close to 80 percent, and the online filing rate for individual returns from self-preparers using tax software is approximately 64 percent, representing a six-percentage-point gain from 2010.
Among paid return preparers the e-file rate is 89 percent. This and the overall increase in e-filed returns results in some degree from the mandate that tax return preparers who file more than 100 individual returns to file electronically.
Refund processing. The IRS processed approximately 107 million tax refunds in 2011, totaling $303 billion and with an average refund amount of $2,836. In addition, the IRS was able to meet its goal of issuing a refund within a 45-day period 99.4 percent of the time.
Refund fraud. The Board also reported that refund fraud was a growing problem fueled by identity theft. In 2011, the IRS was able to stop 1,756,242 fraudulent returns for a total of nearly $14.4 billion in fraudulent refunds stopped.
The IRS Oversight Board reported a drop in the level of service on IRS toll-free telephone lines from 74 percent in FY 2010 to 70 percent in FY 2011, which indicates that three out of every 10 phone callers to the IRS were unable to connect with a telephone assistor. The length of time that the callers waited on average before reaching an assistor was 11.7 minutes, irrespective of the accuracy of the advice received, the Board reported.
The Board questioned if telephone service will be funded adequately in the near future, especially considering the heavy pressure that all federal agencies face to reduce costs. As a consequence, the IRS must take positive steps to lower demand on toll-free telephones by shifting taxpayers to alternative channels that are more cost-effective.
The IRS website has become one of the most popular means by which taxpayers can access tax information, according to the IRS Oversight Board. The IRS Oversight Board reported that in FY 2011 the IRS website received nearly 305 million visits and approximately 76 million taxpayers checked their refund status with the agency's online tool "Where's My Refund?"
The Board reported that the examination coverage rate for taxpayers with income over $1 million was 12 times higher than for individual taxpayers with lower incomes. According to the Board, the audit coverage rate for higher income taxpayers has nearly doubled during the past two years.
Corporations with higher net assets show a higher examination rate, the Board discovered. In 2005 more than 40 percent of tax returns from corporations with $250 million or more in assets were examined.
The Board reported that the most recent tax gap estimate was released by the IRS in January 2012 based on information from the 2006 tax year. The estimated $385 billion tax gap is approximately $95 billion more than the $290 billion net tax gap reported in 2001. The estimated voluntary rate of compliance (VCR) for 2006 is 83.1 percent, which is within the range of error of the previous estimate of 83.7 percent for 2001. The Board noted several IRS programs to reduce the tax gap. These include the return preparer initiative, Schedule UTP, and other programs. The Board had previously approved a long-term goal to achieve a VCR of 86.0 percent by 2012.
According to the IRS Oversight Board's FY 2013 IRS Budget Recommendation Special Report released in April 2012, over the last decade up until two years ago, Congress had slowly and steadily increased the agency's budget. For example, in FY 2002 the IRS had a budget of approximately $9.5 billion, which by FY 2010 had increased to $12.2 billion. During this eight-year period, the Board stated that IRS performance had improved but that budget reductions in FY 2011 and FY 2012 arrested progress in numerous areas such as customer service and tax revenue.
IRS strategic goals
Important strategic IRS goals including improving voluntary compliance through better customer service, improved technology, compliance programs such as the Compliance Assurance Process (CAP) for large business taxpayers, and enhanced identity theft detection. The Board reported that the IRS's outdated information technology systems and the $385-billion tax gap and the IRS's declining resources have made it more difficult for the agency to provide quality service and to enforce the tax laws. The Board predicted that the level of performance will decline again in FY 2012 as a result of reduced IRS budgets.
IRS will consider student loans/state taxes into ability-to-pay analysis
The IRS has released guidance that clarifies and revises its procedures under which agents analyze a taxpayer's ability to pay its tax liability. The guidance now instructs agents to consider payments on student loans and delinquent state and local income tax liabilities when determining whether a taxpayer is able to pay what it owes to the government.
The guidance provides that generally minimum payments on student loans guaranteed by the federal government will be allowed for a taxpayer's post-high school education. Additionally, the IRS may take into account monthly payments on delinquent state and local taxes for certain taxpayers.
When the IRS determines that a taxpayer owes a certain amount of money to the federal government, the collection agent will generally consider one or several courses of action to obtain it. These may include requesting payment in full or in part out of the taxpayer's available assets, filing a lien, entering into an installment agreement to pay back the liability in a series of payments, or making an offer in compromise to settle the liability for less than what is owed. While the IRS decides which action to take, the collection agent is directed by the Internal Revenue Manual to conduct a financial analysis of the taxpayer's financial condition.
To allow minimum payments on student loans, taxpayers must verify that their student loans are guaranteed by the federal government and must substantiate that payments are being made. Taxpayers who have not yet made arrangements to repay their loans have 10 days to set up a payment plan and provide verification. Additional time may be granted for extenuating circumstances. Otherwise an installment agreement generally will be established without allowing for loan payments.
State and local taxes
In certain circumstances monthly payments on delinquent federal and state or local taxes may be allowed for purposes of determining a taxpayer's ability to pay. These include:
When a taxpayer owes both delinquent federal taxes and delinquent state or local taxes and does not have the ability to full pay the liability;
When a taxpayer is cooperative and provides complete financial information; and
When a taxpayer provides verification of the state or local tax liability and agreement, if applicable.
Allowing payments for delinquent state or local taxes for an installment agreement will have no effect on lien or levy priorities, the guidance memorandum warns. IRS agents therefore are instructed "to apply existing procedures and lien law to determine the IRS interest in assets."
Estate tax regulations provide for portability
Legislation enacted in 2010 provided an important estate tax benefit to married couples where the one spouse dies after December 31, 2010 and before January 1, 2013 and is survived by the other spouse. This benefit is known as portability.
For 2011 and 2012, the estate of a deceased individual is entitled to an estate tax exclusion of $5 million. Thus, the estate does not have to pay any estate tax on the first $5 million of estate tax property (determined after the allowance of various deductions).
Carryover of unused amount
If the estate does not need to use the entire $5 million exclusion, the unused exclusion can be now transferred to the estate of the surviving spouse rather than wasted. The IRS identifies this unused estate tax exclusion as the deceased spousal unused exclusion (DSUE). If the deceased spouse had made any gifts before dying, the DSUE is calculated based on the amount of the gift (up to the $1 million gift tax exclusion). The surviving spouse's $5 million estate tax exclusion is increased by the DSUE.
Example 1. Tom and Betty are married. Tom dies in 2011 with a taxable estate of $3 million. Tom's DSUE is $2 million ($5 million less the $3 million estate). When Betty dies, her estate can take an estate tax exclusion of an additional $2 million on top of the regular exclusion ($5 million for 2011 and 2012, subject to change in post-2012 years. Thus, assuming that the regular estate tax exclusion is $5 million when the surviving spouse dies, the total exclusion in the survivor's estate is $7 million ($5 million plus $2 million).
Example 2. The facts are the same, except that Tom made a gift of $1 million is 2009. No gift tax was due because of the gift tax exclusion. The DSUE is $1 million ($5 million less the sum of the $3 million estate and the $1 million gift).
Rules for electing portability
Portability is optional, although it would seem to benefit most estates. The IRS has now issued regulations to explain how estates can elect portability. The regulations require that the executor of the deceased spouse's estate make an affirmative election. The estate makes this election by filing a complete and properly-prepared estate tax return (Form 706) with the IRS.
To make an election, an executor of a small estate (under $5 million) also has to file an estate tax return, even though the estate might not normally have a filing requirement. The regulations simplify some of the reporting requirements if the estate would not normally have a filing requirement.
For the election to be valid, the estate tax return must be filed timely. The estate tax return is due within nine months of the date of death. An estate can obtain one six-month extension to file the return, for a total of 15 months. Every estate making an election must file a timely estate tax return.
If the executor does not wish to elect portability, the executor must provide a statement on the estate tax return that the estate is not electing portability. If the estate is a small estate that does not have a filing requirement, the estate can opt out of portability simply by not filing a timely return.
The DSUE amount is computed using the exclusion of the "last-deceased" spouse. If a spouse dies and the survivor remarries, the regulations explain how to calculate the DSUE.
Only bona fide shareholder loans can create S corp basis
The IRS has issued new regulations that address when S Corp shareholders may increase their adjusted basis because of "indebtedness" of the S corp to them. The shareholder may increase the adjusted basis only if the indebtedness is bona fide. The new rules that elaborate on this basis principle are intended to assist S corp shareholders in determining whether their arrangement with the S corp creates basis of indebtedness. They are also intended to reign in some otherwise legitimate tax strategies. Although these new rules have been issued as proposed regulations that will not formally apply until, on, or after the date the regs are finalized, it is clear that the rules generally represent the IRS's current position and should be ignored only at an S corporation owner's risk.
Code Sec. 1366(d)(1) generally provides that the aggregate amount of losses and deductions that a shareholder has taken into account for any tax year cannot exceed the sum of that shareholder's adjusted basis in stock and adjusted basis of any indebtedness of the S corp to that shareholder. The IRS explained that the Tax Code does not define "basis of indebtedness." However, courts have interpreted Code Sec. 1366 to mean that an investment in the S corp that constitutes an actual economic outlay by the shareholder creates basis of indebtedness. According to the IRS, these cases have generated disputes over when a back-to-back loan gives rise to an actual economic outlay. The proposed regs require that loan transactions represent bona fide indebtedness of the S corp to the shareholder to increase basis in indebtedness. As a bit of good news in otherwise more demanding rules, however, the new rules provide that an S corporation shareholder need not otherwise satisfy the "actual economic outlay" doctrine for these purposes.
Although the IRS expressly did not provide a different standard for what constitutes bona fide indebtedness under Code Sec. 1366, general federal tax principles and facts and circumstances determine whether indebtedness is bona fide. The regs do state, however, that an S corp shareholder that merely acts as a guarantor or in a similar capacity has not created basis of indebtedness unless the shareholder actually made a payment. In such cases, basis is limited to the extent of the payment.
The IRS explained that an S corp shareholder may attempt to obtain basis of indebtedness by borrowing from another person, such as a related entity, and subsequently lending the proceeds to the S corp (a back-to-back loan transaction). Alternatively, an S corp shareholder may seek to restructure an existing loan of the S corp as a back-to-back loan by assuming the S corp's liability on the loan and creating a commensurate obligation from the S corp to the shareholder. According to the IRS, the shareholder can obtain basis only if there is bona fide debt of the S corp that runs directly to the shareholder.
Some S corp shareholders have used what is called the "incorporated pocketbook" theory to claim an increase in basis of indebtedness in circumstances that involve a loan directly to the S corp from an entity related to the S corp shareholder. The arrangement involves an S corp shareholder that claims that a transfer from the related entity directly to the shareholder's S corp was made on the shareholder's behalf and was, in substance, a loan from the related entity to the shareholder, followed by a loan from the shareholder to the S corp. The new regs clarify that an incorporated pocketbook transaction may increase basis of indebtedness only where the transaction creates a bona fide creditor-debtor relationship between the shareholder and the borrowing S corp.
Wednesday, July 4, 2012
Supreme Court hands down landmark health care decision; now what?
On June 28, the U.S. Supreme Court issued its long-awaited landmark decision on the Patient Protection and Affordable Care Act (PPACA) and its companion law, the Health Care and Education Reconciliation Act (HCERA). In a 5 to 4 decision of historic proportions, the nation's highest court upheld the law - except for a certain Medicaid provision involving state funding. Key to the Court's approval of President Obama's signature health care law was the finding that the linchpin individual mandate was constitutional. The requirement under the individual mandate that individuals pay a penalty if they fail to carry minimum essential health insurance coverage was declared within the Constitution based upon Congress's power to tax.
The Supreme Court's decision preserves all of the far-reaching tax provisions and health insurance reforms that were part of the overall health care reform legislation as passed in 2010. In coming months, lawmakers and legal scholars will examine all of the nuances of the Court's highly complex decision. More immediately, individuals and businesses are concerned about what steps they need to take next.
Role of taxes
To a large extent, the Obama administration's health care law is driven by tax provisions, to provide the carrot, the stick and adequate funding in alternating quantities. The role played by taxes in the new health care provisions is also underscored by the predominate part that the IRS will play in its administration.
Under the health care law, a number of tax provisions are scheduled to take effect in 2013 and beyond. The court's decision allows the numerous tax provisions within the health care laws to move forward on schedule. Some important provisions have already taken effect; others will take effect in 2013 and 2014. One provision, the excise tax on high-cost employer-sponsored coverage, will not take effect until 2018.
Main provisions/effective dates
PPACA and HCERA include the following tax provisions (not a complete list):
Small employer Sec. 45R credit, effective for tax years beginning in 2010 - the government will provide a credit of 35 percent of health insurance premiums to small employers (25 percent for tax-exempt organizations. The credit expires after 2015.
Economic substance doctrine, effective after March 30, 2010 - the economic substance test was codified as a two-prong test, requiring that the transaction change the taxpayer's economic position in a meaningful way, and that the taxpayer has a substantial business purpose for the transaction.
Over-the-counter limitations for health accounts, effective for tax years beginning after December 31, 2010 - health accounts, such as flexible spending arrangements, health reimbursement arrangements, health savings accounts, and Archer Medical Savings Accounts, can only reimburse expenses for medicine and drugs if the item is a prescription drug (or insulin).
Indoor tanning services excise tax, effective on or after July 1, 2010 - amounts paid for indoor tanning services are subject to a 10-percent excise tax. Tanning salons must collect the tax and pay it quarterly.
Itemized deduction for medical expenses, effective for tax years beginning after December 31, 2012 - the threshold for deducting medical expenses as an itemized deduction is raised from 7.5 percent to 10 percent of adjusted gross income.
Additional 0.9% Medicare tax, effective after December 31, 2012 - an additional 0.9 percent Medicare tax is imposed on wages and self-employment income of higher-income individuals: individuals - above $200,000; married filing jointly - above $250,000; married filing separately - above $125,000.
3.8% Medicare contribution tax, effective after December 31, 2012 - a 3.8 percent Medicare tax is imposed on unearned income for higher-income individuals, including interest, dividends, annuities, royalties, rents and other passive income.
Medical device excise tax, effective for sales after December 31, 2012 - a 2.3 percent excise tax is imposed on sales of certain medical devices by manufacturers, producers and importers. Retail items such as eyeglasses are excluded from the tax.
Employer shared responsibility, effective after December 31, 2013 - the "employer mandate": an applicable large employer (50 or more full-time employees) must make a payment if any full-time employee can receive the premium tax credit. The payment is required if the employer does not offer minimum essential coverage, or offers coverage that is not affordable.
Branded prescription drug fees, effective for calendar years beginning after December 31, 2010 - an annual fee imposed on manufacturers and importers with receipts from branded prescription drug sales.
Sec. 36B premium assistance credit, effective for tax years ending after December 31, 2013 - lower-income individuals who obtain health insurance coverage through an insurance exchange may qualify for the credit, unless they are eligible for other minimum essential coverage.
Excise tax on high-dollar insurance, effective for tax years beginning after December 31, 2017 - employer-sponsored health coverage whose cost exceeds a threshold amount ($10,200 for self-on coverage; $27,500 for other coverage) will be subject to a 40-percent excise tax.
Employers, taxpayers - indeed everyone - must prepare for sweeping changes in health care in coming years. Many of the provisions in the PPACA have already been implemented or are in the process of being implemented. Other provisions, as the above list indicated, are scheduled to take effect after 2012. The Supreme Court's upholding of the PPACA clears the way for full implementation of the new law (unless a future Congress votes to repeal the law, which at this point would be an uphill battle).
Please contact Doeren Mayhew, a Michigan CPA Consulting Company, for more information.
Summer brings likely slowdown in progress of tax legislation in Congress
As summer arrives in Washington, so does the usual slowdown in legislative activity and 2012 appears to be no exception. Lawmakers have a full plate of tax-related bills on their agenda but progress is slow at best as both parties prepare for the November elections. Among the pending tax bills are proposals to extend bonus depreciation, enact small business tax incentives, renew many expired extenders, and more.
Bonus depreciation. In 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act provided for temporary 100 percent bonus depreciation. Generally, 100 percent bonus depreciation was available for qualifying property placed in service after September 8, 2010 and before January 1, 2012 (or before January 1, 2013 in the case of property with a longer production period and certain noncommercial aircraft).
One hundred percent bonus depreciation is one of the few tax incentives on which Democrats and Republicans have found common ground. President Obama has indicated his support for extending 100 percent bonus depreciation one additional year. House Democrats introduced the Invest in America Now Act, which would extend 100 bonus depreciation through 2012 (through 2013 in the case of property with a longer production period and certain noncommercial aircraft). The cost of repeal would be offset by denying the Code Sec. 199 domestic production activities deduction to oil and gas producers.
Reminder. The 2010 Tax Relief Act also provided for 50 percent bonus depreciation for qualifying property placed in service before January 1, 2013 (or before January 1, 2014 in the case of property with a longer production period and certain noncommercial aircraft).
Small businesses. Democrats and Republicans have unveiled competing small business tax bills. The House approved a GOP-written bill, the Small Business Tax Cut Bill (HR 9). Under the House bill, small businesses with fewer than 500 employees could claim a 20 percent deduction on qualified income in 2012. The deduction would be capped at 50 percent of qualified wages.
Meanwhile, Senate Democrats proposed their Small Business Jobs and Tax Relief Act of 2012 (Sen. 2237). The bill would generally provide a 10 percent income tax credit on new payroll added by a qualified small employer in 2012. The credit would be capped at $500,000. The Senate has not yet voted on the Democratic bill.
Tax incentives for small businesses have enjoyed bipartisan support in the past. The GOP bill passed the House with Democratic support. However, the GOP bill is not expected to be approved by the Senate if the bill comes up for a vote.
Bush-era tax cuts. House Speaker John Boehner, R-Ohio, said in May that the House will vote on an extension of the Bush-era tax cuts before the November elections. No legislation has been introduced and no vote scheduled. It is unclear if House Republicans will propose extending the Bush-era tax cuts after 2012 without any offsets or if their bill will carry some revenue raisers. House Republicans may also link an extension of the Bush-era tax cuts to spending cuts and budget reforms. The Budget Control Act of 2011 mandates across-the-board spending cuts in 2013 and beyond. In May, the House passed the Budget Sequestration Bill (HR 5652). The bill provides a substitute for the Budget Control Act. The Senate is not expected to take up the Budget Sequestration Bill.
President Obama has reiterated his opposition to extending the Bush-era tax cuts for higher income taxpayers. The White House generally defines higher income taxpayers as individuals with incomes over $200,000 and families with incomes over $250,000. Recently, some Democrats have spoken of higher thresholds, in the neighborhood of $1 million. Lawmakers have also voiced the idea of a six-month or one-year extension of the Bush-era tax cuts.
Tax extenders. It appears that lawmakers may not automatically renew all of the expired extenders as they have routinely done in past years. In June, the chair of the Senate Finance Committee, Sen. Max Baucus, D-Montana, said that lawmakers should look at each extender and decide whether to eliminate it or make it permanent. Baucus did not indicate which extenders should be made permanent and which should be jettisoned from the Tax Code. Among the likely candidates for being made permanent are the research tax credit, the higher education tuition deduction and the teachers' classroom expense deduction. All of these extenders have enjoyed bipartisan support.
Often included among the extenders is the so-called alternative minimum tax (AMT) patch. The patch provides higher exemption amounts so the AMT does not encroach on middle income taxpayers. The latest patch expired after 2011. Proposals to extend the patch for 2012 have stalled, again over cost. Lawmakers could leave the fate of the patch until after the 2012 elections. However, late enactment of a patch would likely delay the start of the 2013 filing season because the IRS would need to reprogram its processing systems.
Pension funding. Democrats and Republicans agree that the reduced interest rates on federal student loans should be extended one more year but disagree on how to pay for the estimated $6 billion cost of a one-year extension. Changes to pension funding rules have been discussed as one way to pay for an extension of reduced federal student loan interest rates.
IRS budget. The House and Senate are preparing for a showdown over the IRS' fiscal year (2013) budget. The House approved an $11.8 billion FY 2013 budget for the IRS budget. The Senate is expected to approve a $12.5 billion FY 2013 budget. Both amounts are, however, less than the funding levels requested by President Obama. IRS Commissioner Douglas Shulman has warned Congress that reduced funding will negatively impact enforcement and customer service. In FY 2012, Congress cut the IRS budget by $305 million and the agency responded by offering buyouts and early retirements to approximately 4,000 employees.
Transportation. Agreement on a comprehensive transportation funding bill with tax offsets has eluded lawmakers. The Senate passed the Moving Ahead for Progress in the 21st Century Act (MAP-21)(Sen. 1813). MAP-21 would provide parity among transit benefits, which had expired after 2011; allow Treasury to take a variety of measures against foreign financial institutions that engage in money laundering; and deny passports to individuals with seriously delinquent tax debt. House Republicans have a transportation bill but have not been able to pass it. Lawmakers are reportedly preparing another temporary extension of current funding.
Energy. A number of energy tax incentives expired after 2011 and progress to renew them has stalled. They include popular incentives for wind energy production and biomass fuels. President Obama proposed to repeal oil and gas tax preferences to pay for an extension of some of the energy incentives but lawmakers have shown little interest.
More proposals. Many other tax bills are pending, including legislation to:
Extend or make permanent the American Opportunity Tax Credit
Repeal the excise tax on medical devices
Revise health flexible spending arrangement rules for over-the-counter medications
Extend the enhanced Work Opportunity Tax Credit for veterans
Provide for tax rate parity among tobacco products
Repeal the federal estate tax
Enhance tax-exempt bonds
If you have any questions about pending tax legislation, please contact Doeren Mayhew, a Michigan CPA Consulting Company, for more information.
Maximizing the benefits of dependency tax status not always straightforward
The dependency exemption is a valuable deduction that may be lost in many situations simply because some basic rules for qualification are not followed. Classifying someone as a dependent can also entitle you to other significant deductions or credits. Here is a rundown of some of the rules and their implications.
Exemptions reduce your adjusted gross income. There are two types of exemptions: personal exemptions and exemptions for dependents. For each exemption you can deduct $3,800 on your 2012 tax return. In computing the amount to be withheld from an employee's wages, the employee is entitled to an allowance equal to the exemption amount used to calculate the personal exemption deduction. On a joint return, you may claim one personal exemption for yourself and one for your spouse. If you're filing a separate return, you may claim the exemption for your spouse only if he or she had no gross income, is not filing a joint return, and was not the dependent of another taxpayer.
Exemptions for dependents. You generally can take an exemption for each of your dependents. A dependent is your qualifying child or qualifying relative. In some circumstances, even an aged parent who lives with you may qualify. No personal exemption is allowed for a dependent or any other individual unless the taxpayer identification number (TIN) of that individual is included on the return claiming the exemption. The TIN generally must be a social security number (SSN).
Support test. A qualifying child must not have provided more than one-half of his or her own support during the calendar year in which the taxpayer's tax year begins. In contrast, the taxpayer must provide at least one-half of a qualifying relative's support in order to claim the relative as a dependent.
As of the close of the calendar year in which the taxpayer's tax year begins, a qualifying child must not have attained the age of 19, or must be a student who has not attained the age of 24. This age test does not apply to a child who is permanently and totally disabled at any time during the calendar year in which the taxpayer's tax year begins. A student for this purpose is an individual who, during each of five calendar months of the calendar year in which the taxpayer's tax year begins, is a full-time student at an educational organization, or is pursuing a full-time course of instructional on-farm training. This five-month rules generally enables most parent of college students graduating in May to take their child as an exemption "one last time."
An adoptive parent in the process of a domestic adoption who has custody of the child pending the final adoption and who provides enough financial support during the year is entitled to claim a dependency exemption for the child.
Possible downsides of being a dependent. If someone else - such as your parent - claims you as a dependent, you may not claim your personal exemption on your own tax return. Further, some people cannot be claimed as your dependent. Generally, you may not claim a married person as a dependent if they file a joint return with their spouse. Also, to claim someone as a dependent, that person must be a U.S. citizen, U.S. resident alien, U.S. national or resident of Canada or Mexico for some part of the year. There is an exception to this rule for certain adopted children.
An individual who qualifies as another taxpayer's dependent cannot claim any amount for a personal exemption, even if the individual files a return and the other taxpayer does not actually claim the individual as a dependent. For instance, in a court case in which a college student filed his own return, he was not entitled to any deduction for his personal exemption because he also qualified as his parent's dependent, even though they did not actually claim his exemption.
Ancillary benefits. As discussed, a dependent cannot file joint returns or claim dependency exemptions. In addition, a dependent who is a qualifying relative cannot have income in excess of the annual exemption amount. However, these restrictions do not apply to a person's classified as dependents for several other tax items. If a person would qualify as a dependent but for filing a joint return, claiming dependency exemptions, or having gross income in excess of the exemption amount, the person is nonetheless treated as a dependent for the following purposes (not a complete list):
the taxpayer's head-of-household filing status;
the exception from the early distribution penalty for qualified retirement plan distributions used to pay health insurance premiums for an unemployed taxpayer's dependents;
the exclusion from income of amounts received under accident and health insurance plans;
the definition of a highly compensated participant for purposes of cafeteria plans;
the exception from the rules that allow certain amounts paid to maintain a student in the taxpayer's home to qualify as deductible charitable contributions;
the deduction for medical expenses incurred by the taxpayer's dependent;
the exclusion for distributions from an Archer medical savings account (MSA) that are used to pay a dependent's medical expenses;
the rules governing the deduction for qualified student loan interest; and the treatment of educational and medical indebtedness in calculating the value of a decedent's qualified family-owned business interests for purposes of the estate tax.
As you may gather, the rules associated with the dependency exemption can get complex rather quickly. If you need any assistance in sorting out any dependency exemption or related benefits, please you do hesitate to contact Doeren Mayhew, a Michigan CPA Consulting Company, for more information.
How do I....Make matching contributions to a SIMPLE IRA plan?
A SIMPLE (Savings Incentive Match Plan for Employees of Small Employers) IRA is a retirement savings plan designed specifically for small employers. A SIMPLE IRA is an IRA-based plan with ease of use features intended to encourage small employers, which may otherwise not offer a retirement plan, to create a retirement plan.
Generally, any business with 100 or fewer employees can establish a SIMPLE IRA. If an employer establishes a SIMPLE IRA plan, all employees of the employer who received at least $5,000 in compensation from the employer during any two preceding calendar years (whether or not consecutive) and who are reasonably expected to receive at least $5,000 in compensation during the calendar year, must be eligible to participate in the SIMPLE IRA. For purposes of the 100-employee limitation, all employees employed at any time during the calendar year are taken into account
SIMPLE IRAs must be established under a written plan agreement. All employees must be notified about the SIMPLE IRA plan. Generally, employees must be informed about his or her opportunity to make or change a salary reduction choice under the SIMPLE IRA plan and the employer's decision to make either matching contributions or nonelective contributions. Employees are always 100 percent vested in a SIMPLE IRA.
Salary reduction contributions
SIMPLE IRAs are subject to important limits on salary reduction contributions. The limit is $11,500 for 2012. However, employees age 50 or over may make so-called $2,500 "catch-up" contributions for 2012.
Employers have two choices in determining their contributions to a SIMPLE IRA plan:
A two percent nonelective employer contribution, where employees eligible to participate receive an employer contribution equal to two percent of their compensation (limited to $245,000 per year for 2012 and subject to cost-of-living adjustments for later years), regardless of whether the employee makes his or her own contributions.
A dollar-for-dollar match, up to three percent of compensation, where only the participating employees who have elected to make contributions will receive an employer contribution (this is called a matching contribution).
Each year, employers can choose which one they will use for the next year's contributions. This choice must be communicated to employees. Owners of small businesses can use SIMPLE IRA plans as vehicles for retirement savings for themselves without reference to how many of their employees actually participate, as long as the employees are given the option.
The three percent matching contribution applies if the employee has made a contribution. In contrast, the two percent nonelective contribution applies even if the eligible employee did not make a contribution.
Let's look at an example: Jacob, age 29, has worked for his employer for five years. This year, the employer established a SIMPLE IRA plan for Jacob and its other 44 employees. The employer will match contributions made by Jacob and the other employees dollar-for-dollar up to three percent of each employee's compensation. Jacob contributes three percent of his yearly compensation to his SIMPLE IRA (three percent of $40,000 or $1,200). His employer's matching contribution is also $1,200. The total contribution to Jacob's SIMPLE IRA is $2,400.
The three percent limit on matching contributions may be reduced for a calendar year at the election of the employer, but only if the limit is not reduced below one percent; the limit is not reduced for more than two years out of the five-year period that ends with (and includes) the year for which the election is effective; and employees are notified of the reduced limit within a reasonable period of time before the 60-day election period during which employees can enter into salary reduction agreements. If an employer fails to satisfy the contribution rules, the SIMPLE IRA plan is in jeopardy of losing its tax benefits for the employer and all participants.
If you have any questions about matching contributions to SIMPLE plans or how to set up a SIMPLE plan, please contact Doeren Mayhew, a Michigan CPA Consulting Company, for more information.
FAQ...Has IRS Fresh Start penalty relief expired?
Yes, penalty relief under the IRS Fresh Start initiative was a one-time offer, which required individuals to file Form 1127-A, Application for Extension of Time for Payment of Income Tax for 2011 Due to Undue Hardship, by April 17, 2012.
The Tax Code imposes penalties on individuals who fail to file a return when one is required to be filed and on individuals who fail to pay any tax by the due date. Often, taxpayers find that penalties can be more onerous than the taxes actually owed.
The penalty for filing a return late is generally five percent of the unpaid taxes for each month or part of a month that a return is late. The IRS has explained that this penalty will not exceed 25 percent of your unpaid taxes. Individuals who fail to pay their taxes by the due date, generally are liable for a failure-to-pay penalty of one-half of one percent of the unpaid taxes for each month or part of a month after the due date that the taxes are not paid. The IRS has cautioned that the penalty can be as much as 25 percent of the unpaid taxes.
If both the failure-to-file penalty and the failure-to-pay penalty apply in any month, the failure-to-file penalty is reduced by the failure-to-pay penalty. However, if you file your return more than 60 days after the due date or extended due date, the minimum penalty is the smaller of $135 or 100 percent of the unpaid tax.
Generally, the period of delinquency runs from the day after the due date of the return until the return is actually received by the IRS. In determining the number of months for which the penalty is imposed, the due date of the return determines when months begin and end. Individual returns for 2011 were due April 17, 2012.
Fresh Start relief
In early 2012, the IRS announced special penalty relief for individuals who found themselves unable to pay their taxes by the April 17 due date. This relief was part of the IRS' "Fresh Start" initiative.
Penalty relief was available to two groups:
Wage earners who had been unemployed at least 30 consecutive days during 2011 or in 2012 up to the April 17, 2012 deadline for filing a federal tax return this year.
Self-employed individuals who experienced a 25 percent or greater reduction in business income in 2011 due to the economy.
The taxpayer also had to have adjusted gross income of less than $100,000 (or $200,000 for a married couple filing a joint return). Additionally, the amount owed to the IRS had to be less than $50,000.
Under the Fresh Start initiative, interest runs on the 2011 taxes until the tax is paid. However, no failure-to-pay penalties will be incurred if tax, interest and any other penalties are paid in full by October 15, 2012.
The IRS required taxpayers to file Form 1127-A to request penalty relief by April 17, 2012. At this time, it appears that the IRS is not bending this rule. However, the IRS could adjust its approach. If the IRS announces any changes, our office will keep you posted.
Doeren Mayhew, a Michigan CPA Consulting Company, for more information.
July 2012 tax compliance calendar
As an individual or business, it is your responsibility to be aware of and to meet your tax filing/reporting deadlines. This calendar summarizes important tax reporting and filing data for individuals, businesses and other taxpayers for the month of July 2012.
July 5 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 27-29.
July 9 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates June 30-July 3.
July 10 Employees who work for tips. Employees who received $20 or more in tips during June must report them to their employer using Form 4070.
July 11 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 4-6.
July 13 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 7-10.
July 18 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 11-13.
July 20 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 14-17.
July 25 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 18-20.
July 27 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 21-24.
August 1 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 25-27.
August 3 Employers. Semi-weekly depositors must deposit employment taxes for payroll dates July 28-31.
Contact Doeren Mayhew, a Michigan CPA Consulting Company, for more information.