CPA With a View

Frank is here

My new grandson Frank James was born on Feb. 17. Frankie is awesome. A beautiful 8.5 pound baby boy. Another tax accountant in the family. He received his first tax code on Feb. 18.

That makes 8 grandchildren; all under seven years old. What a blast. We were lucky enough to keep Frankie’s two sisters (Cami and Kiera) and his brother (Vinny) at our house while mom was delivering the new guy.

What a fantastic weekend.  Nothing better than family.

The Green Book is Out

The U.S. Treasury Department released the “General Explanation of the Administration’s Fiscal Year 2013 Revenue Proposal” (The Green Book-because it has a green cover). It is 200 pages of the Obama Administration’s proposal for changes in the tax law in 2012 and beyond.

A few of the proposals are highlighted below: 

• A tax credit for increased wages paid to employees.
• 100% bonus depreciation for 2012.
• Payroll tax reduction extension to the end of 2012.
• For years after 2013, repeal LIFO and lower-of-cost-or-market inventory valuation methods. LIFO reserves would be picked up in income over a 10-year period.
• Tax LLC and Partnership “profits interests” issued for services as ordinary income.
• Provides a variety of tax incentives for generating business and jobs in the U.S. and tax disincentives for transferring business and jobs outside the U.S.

Individual Tax Proposals beginning in 2013:

• Increase the highest-two tax brackets of 33% and 35% to 36% and 39.6%, starting when income equals $250,000 for a joint return and $200,000 on a single taxpayer’s return.
• Tax a portion of dividends at ordinary tax rates for high-income taxpayers.
• Increase long-term capital gains from 15% to 20% and add the Buffet Tax explained in my last BLOG post.
• Start itemized deduction and exemption phase-outs for high-income taxpayers.
• Limit the rate in which itemized deductions reduce taxes to 28% of the deduction for certain high-income taxpayers.

Estate and gift tax proposals:

• For taxpayers who die after 2012, the estate and gift tax rules would basically be what was in effect in 2009.  A 45% tax rate with a $3,500,000 Estate Tax and Generation-Skipping Transfer (GST) Tax  exclusion amount per person. Portability among spouses of the exclusion amount would still apply. The lifetime gift tax exclusion would be limited to $1,000,000. Currently, the exclusion amount for Estates, GST and gifts is $5,000,000 and tax rate is 35%.
• GRATs (grantor retained annuity trusts) would be required to have at least a 10-year term and generate some value in the remainder interest.
• New rules would greatly reduce the estate tax benefit of using Grantor Trusts, by coordinating the income tax and estate treatment of such trusts. This is a big deal.

The Green Book is truly a wish list by the Administration. Whether any or all of the items get enacted, will rest with the make-up and direction of Congress, after the election.  

We will see. It will be fun being involved in the process.

Fair Share Tax

The Paying Fair Share Act of 2012 (S-2059) was introduced to the Senate and referred to the Finance Committee by U.S. Senator Sheldon Whitehouse (D-RI) on February 1, 2012.

The goal of the bill is to reduce the deficit by imposing a minimum effective tax rate for high-income taxpayers.

The bill would add Section 59B to the Internal Revenue Code.  If it becomes law, it would be effective beginning in 2013.  It applies to individuals with adjusted gross income in excess of $1,000,000.  This includes all income, for example S-corporation or LLC pass-through income, and capital gains, including gains from the sale of one’s business.

The tax is basically a flat tax of 30% of total adjusted gross income less charitable contributions. The tax would be offset by certain self-employment taxes and payroll taxes incurred by the taxpayer, including the special Medicare taxes that become effective in 2013, pursuant to the 2009 Health Care Bill.

The tax is structured as a second additional minimum tax. The additional tax is the excess of the total tax under Section 59B; less the taxpayer’s regular tax and additional alternative minimum tax (AMT); and less certain credits and payroll taxes mentioned above. The additional amount is phased in for taxpayers with adjusted gross income between one and two million dollars. The full additional amount applies if one’s adjusted gross income is $2,000,000 or more.

For example, assume a taxpayer sold his/her business in 2013 and recognized a $3,000,000 capital gain and also had $400,000 of other ordinary income. In addition, assume itemized deductions for taxes, home interest and charitable deductions ($200,000) equaled $400,000.  In this example, the person’s regular and AMT tax would be approximately $475,000. Under the the Paying Fair Share Act there would be additional taxes of $365,000, calculated as follows:

$3,000,000 less $200,000 (charitable contribution) times 30% equals $840,000. Reducing the $840,000 by the regular and AMT tax of $475,000 results in the Section 59B fair share tax of $365,000.

What a hit for a small business owner who took major risks and created jobs over the years. You judge the fairness. You know my thoughts.

The good news is the S-Corporation Association is aware of the bill.  The Association understands how it impacts small business, especially flow-through entities like LLCs and S-Corporations, and will be working to educate Congress on the impact of this provision.

Also, based on my conversations with contacts in Washington, D.C., it doesn't seem likely this type of legislation could pass with the current make-up of Congress and the fact that it is an election year.  It truly seems to be a political play.  That's too bad.

More to come.

Caribbean

My wife and friends are back from the sailing trip in the Caribbean. Sounds like I should have joined them, relaxing and sailing for a week.  At least I got to walk my dog in the freezing cold in Minnesota four times a day.  There is always next year.

Passive Activity Rules – Part II

As I mentioned in my post last week, Internal Revenue Code (IRC) Section 469 states that losses from passive activities can only be deducted against income from passive activities or when the activity is disposed. Generally, passive activity is any trade or business owned by the taxpayer that the taxpayer does not materially participate in and/or any rental activity owned by the taxpayer.

Last week, I highlighted rules used to determine what is or is not 1) material participation or 2) a rental activity.  This week you’ll find special passive loss rules relating to the definition of rental operations, certain activities that are passive and non-passive, and grouping of activities.

Below are a few of the special rules:

1)      Special rules under Treasury Regulation 1.469-1T(e)(3) define what constitutes a rental activity and what is not a rental activity. Generally, the level of service provided with the property determines whether it is rental activity or not.

2)      The re-characterization rules in Treasury Regulation 1-469-2T(f) provide that certain activities are passive if they generate a loss, and not passive if they generate income (i.e. the worst of both worlds). The most common is a rental activity whereby the property is rented to an activity in which the taxpayer materially participates.

3)      The self charged interest (and guaranteed payments for capital) rules of Treasury Regulation 1.469-7 provide that interest income received by a taxpayer from a loan to a passive activity owned, all or part, by the taxpayer is passive income to the extent the offsetting interest expense of the activity is allocated to such taxpayer. The rules also indicate that interest income from a loan from a pass-through entity allocated to the lender is treated as passive income if the lender invested the funds in a passive activity.

4)      The grouping rules of Treasury Regulation 1.469-4(3), 1.469-4(f) and 1.469-11 must be reviewed to determine whether one can or must group certain business operations and rental operations under the passive loss rules. It may or may not be beneficial to group. One must look at their specific facts and circumstances in determining the proper course of action. I highly recommend looking at the rules before your tax return is complete to determine what makes sense and how you can reduce your disallowed passive losses.

5)      With regards to grouping business operations and rental activities, Revenue Procedure 2010-13 requires one to disclose new activities, new groupings and regroupings beginning with 2011 tax returns. Generally, once an activity is grouped (which includes not being grouped), it cannot be regrouped unless the original grouping was clearly inappropriate or a material change in the situation has occurred that makes regrouping appropriate.

The key is to review all business and rental activities to determine which, if any, of the rules apply and/or if you should be changing your grouping to minimize any negative impact of the passive loss rules.

Tax Season is Here-No Caribbean

Tax season is here. I love this time of year. Meeting with clients and bringing value. It gets really crazy busy, but it truly is a blast.  My wife and I had a tripped planned on a sail boat with friends in the Caribbean this week. Due to the time of year and the fun at the office, I pulled out of the trip last week and her friend is taking my place.

Now you truly know the real me. I would rather enjoy being with my team during tax season, than on a boat in the Caribbean. After tax season it is a different story, back on the water.

Passive Activity Rules - Review Your Status

Internal Revenue Code (IRC) Section 469 states that losses from passive activities can only be deducted against income from passive activities or when the activity is disposed. Generally, passive activity is any trade or business owned by the taxpayer that the taxpayer does not materially participate in and/or any rental activity owned by the taxpayer.

There are a variety of rules used to determine what is or is not 1) material participation or 2) a rental activity. Taxpayers and return preparers should review the rules each year to determine the correct classification (passive or non-passive) of the activity. Depending on the circumstances, one may want an activity to be classified as passive. For example, if the activity generates income, the income can be offset by other passive losses.

The basic rule is that one must participate more than 500 hours in a year to achieve material participation status. There are a few exceptions, see Treasury Regulation 1.469-5 and 1.469-5-T  for the rules.

Below are a few of the unusual rules relating to participation that may impact the classification of a business activity:

1)      When determining material participation in an activity, only participation when the activity is owned by the taxpayer counts. Therefore, if the activity is acquired or started late in the year, it may be difficult to meet the various hours-worked rules for material participation.

2)      If one is a limited partner in a limited partnership, the more than 500 hours of participation rule must be used to determine whether the partner passes the material participation event. LLC members may or may not be treated as limited partners under this rule, based upon the particular facts and circumstances.

3)      Participation by the taxpayer’s spouse counts as participation, even though the spouse has no ownership in the activity.

4)     If one materially participated in an activity 5 out of the last 10 years, they are considered to materially participate in the current year. The rule is 3 out of 5 years for Personal Service Activities.

5)     Time “on call” to perform service does not count as participation.

6)     All work and services provided count as participation except:

a) Work not customarily done by an owner won’t count if one of the principal purposes for doing the work is to obtain material participation status.

b)  Work performed as an investor not working day-to-day in the business is ignored. For example, reviewing financial statements or strategic plans in a non-managerial capacity.

7)      The executor or fiduciary of an estate or trust must materially participate in the activity for the activity to be considered non-passive to the estate or trust.

Next week, I will post some of the unusual rules relating to the definition of rental operations, certain activities that are passive and non-passive, and grouping activities into one.

The key is to review all business and rental activities each year and determine the proper status (passive or non-passive).  Then, work with your CPA to determine what can be done to classify them in the best way for tax purposes.

Grandma Turns 90

Sunday we celebrated Grandma’s 90^th birthday. Awesome Italian cook. I love her food. She gave me my awesome Italian wife. We celebrated at the boat house with 8 grandchildren and 18 great grandchildren. Pretty special day.

Stones Tour Rumor  

The rumors are picking up on a 2012 Stones tour. It would be a celebration of their 50^th year as a band. WOW would that be fun. Tax blogging from a Stones show. Can’t beat it.

Charitable Contributions

It's time to start gathering your 2011 tax information.

To take a deduction for charitable contributions, one must meet the substantiation and reporting requirements.  Using "same as last year" or "the normal amount" is not an option.

Below is a short summary of the requirements.

Contributions of less than $250

- Cash:  A bank record verifying the donee, the date and amount (i.e. a cancelled check or bank statement), a receipt from the donee verifying the date and amount, or payroll deduction record and pledge.

- Non Cash:  A receipt from the donee, the date of the contribution, description of the property and location of the property. One must also maintain documentation proving the value of the property and how it was determined, the date acquired and basis of the property, the percent of the property given, and any terms or conditions connected to the contribution.

Contributions of $250, but less than $500

- Cash:  Same as above plus a written acknowledgement from the donee indicating 1) the date and amount of the contribution, 2) whether or not any goods and services were provided by the donee as a result of the contribution, other than an intangible religious benefit, and if so, the value of such benefits.

-  Non Cash:  Same as cash above plus a description of the property and its location.

Contributions of more than $500 to $5,000

-  Cash:  Same as the $250 but less than $500 category.

-  Non Cash: Same as the $250 but less than $500 category plus Form 8283 needs to be filed and include how and when the property was acquired and the basis of the property.

Contributions of more than $5,000

-  Cash:  Same as the previous category.

-  Non Cash:  Same as above plus one must obtain a qualified appraisal, complete page two of Form 8283, and the appraiser and donee must sign Form 8283.

The instructions to Schedule A and Form 8283 and publications 17, 526,561, and 4303 include guidelines and explanations of the rules. These resources provide helpful information such as special exceptions for reporting contributions of marketable securities and small non-traded securities, vehicle donation, and understanding when “similar items” donated during the year to various charities get combined in determining which category above applies. These resources can be found on the IRS website.  www.irs.gov

New Years and Great Birthday Party

Had a great New Years in Florida. My wife Jan and I had a great time boating on "Miss You" our deck boat. Yes, it does have a Rolling Stones tongue on the back. I love being on the water. The bars are fun too.

Just celebrated Cami's sixth birthday at the Boat House Condo party room and indoor pool. What a great time with my family. Cami was so happy and beautiful. I love her.

Extension of the Payroll Tax Holiday

The House of Representatives agreed to pass the Senate version, with a slight modification, of the Bill to extend for two months (thru 2/29/12) the current 2% reduction in payroll taxes. The House and Senate will ratify it and the President is expected to sign it today.

The new House bill corrects the Senate provision by allowing employers to withhold employee payroll taxes at the 2% reduced rate of 4.2% on all compensation paid from 1/1/12 to 2/29/12, subject to the full Social Security tax wage base ($110,100). Consequently they can ignore the $18,350 cap (two-twelfths of the wage base of $110,100) on compensation eligible for the form 1/1/12 to 2/28/12 included in the Bill.

If an employee’s wages during the first two months of 2012 exceed $18,350, an amount equal to 2% of those excess wages would ultimately be recaptured on the worker’s individual tax return for 2012. 

This rule would only apply if the payroll tax reduction is not extended to the end of 2012 in the upcoming conference committee sessions expected to convene soon in order to negotiate a full-year extension or other 2012 legislation.

In other words, they aren’t done yet. Can’t wait to watch it unfold. 

Merry Christmas.

Payroll Tax Extension

As many of you may know, the House and Senate are fighting over how to a pass an extension of the payroll tax cut.  If they come to an agreement, I will submit a short post. 

Merry Christmas

My son is home from the military.  I look forward to spending time with him over the next week.  I will not be posting again until 2012, unless there is news out of Congress relating to the payroll tax extension.  Hope everyone has a Merry Christmas.

NEW Enhanced Work Opportunity Tax Credit (WOTC) for Hiring Qualified Veterans

The “3% Withholding Repeal and Jobs Creation Act”, signed into law Nov. 21, 2011, expands and extends the work opportunity tax credit (WOTC) for employing certain military veterans.

Please note, this is a technical blog post, but I believe it will help. I am a big supporter of our troops and anything that helps them deserves attention.

The WOTC allows employers who hire members of certain targeted groups, including qualified veterans, to get a credit against income tax of a percentage of first-year wages up to $6,000 per employee ($12,000 for certain qualified veterans; and $3,000 for qualified summer youth employees). Generally, the percentage of qualifying wages is 40% of first-year wages, for a maximum WOTC of $2,400 (40% × $6,000), or $4,800 for certain qualifying veterans (40% × $12,000). The 40% is reduced to 25% for employees who have completed at least 120, but less than 400, hours of service for the employer during the first year. 

The new law extends the existing WOTC for hiring qualified veterans, broadens the classes of qualified veterans, increases the WOTC for hiring some of them, “fast-tracks” the qualification process for qualified veterans, and provides tax-exempt employers with a credit against payroll tax for hiring qualified veterans.

Under the new law, employers will be able to claim the WOTC for qualified veterans who begin work for the employer before Jan 1, 2013. In other words, the WOTC gives a one-year extension to employers that hire qualified veterans.

Effective for individuals who begin work for the employer after Nov. 21, 2011, a qualified veteran is a veteran who is certified by the designated local agency as falling within one of the following four categories:

(1) The individual is a member of a family receiving assistance under a food stamp program under the Food Stamp Act of '77 for at least three months, all or part of which is during the 12-month period ending on the hiring date.

(2) The individual is entitled to compensation for a service-connected disability, and either:

  (a) has a hiring date that isn't more than one year after having been discharged or released from active duty in the U.S. Armed Forces, or

  (b) has aggregate periods of unemployment during the 1-year period ending on the hiring date that equal or exceed six months.

(3) The individual has aggregate periods of unemployment during the 1-year period ending on the hiring date which equal or exceed four weeks (but less than six months).

(4) The individual has aggregate periods of unemployment during the 1-year period ending on the hiring date which equal or exceed six months.

The maximum amount of qualifying first-year wages for which the WOTC may be claimed is:

(A) $12,000 for an individual who is a qualified veteran, is entitled to compensation for a service-connected disability, and has a hiring date that isn't more than one year after having been discharged or released from active duty in the U.S. Armed Forces.

(B) $24,000 for an individual who is a qualified veteran, is entitled to compensation for a service-connected disability, and has aggregate periods of unemployment during the 1-year period ending on the hiring date which equal or exceed six months.

 (C) $14,000 for an individual who is a qualified veteran and has aggregate periods of unemployment during the 1-year period ending on the hiring date which equal or exceed six months.

(D) $6,000 for veterans who qualify under the family assistance rule above and for veterans who qualify under the new category (i.e., veterans who are unemployed for four weeks or more, but less than six months).

The enhanced maximum amounts of qualifying wages also seem to apply if the qualified veteran completes at least 120, but less than 400, hours of service for the employer during the one-year period beginning with his or her hire date. For these reduced hours, the reduced credit percentage (25%) applies.

The IRS, at its discretion, may provide alternative methods for certification of a veteran who is a qualified veteran.

Tax-exempt employers get a payroll-tax credit for hiring qualified veterans. A tax-exempt employer may, subject to the limits described below, claim a WOTC for hiring qualified veterans. The credit is allowed against the Social Security Tax that exempt employers pay on the wages of all of their employees.

The credit applies to both the old categories of qualified veterans and the new categories created by the new law.

The following modifications apply to tax-exempt employers’ WOTC calculation.

• The credit percentage of qualifying first-year wages is 26% (instead of 40%).
• The credit percentage is 16.25% (instead of 25%) for a qualified veteran who has completed at least 120, but less than 400, hours of service for the employer.
• The tax-exempt employer may only take into account wages paid to a qualified veteran for services in furtherance of the activities related to the purposes or function constituting the basis of the organization's tax-exempt status.

 

WOW that is enough information.

If you are hiring, please contact your state employment agency, get a list of qualified veterans waiting for a job and take a look at them. They served our country to protect our freedom. The least we can do is give them a shot. You get a WOTC to boot.  My son is currently serving -  served two tours in IRAQ.  His grandfathers served in WW II and my niece’s son is serving in Afghanistan. Thank God for our troops.

Year-End Planning: Plan to Maximize Your Domestic Production Deduction

Businesses can claim a domestic production activities deduction (DPD) under Internal Revenue Code (IRC) Section 199 to offset income from domestic manufacturing and other domestic production activities.

The DPD equals 9% of the smaller of:

(1) the taxpayer's "qualified production activities income" (QPAI) or

(2) the taxpayer's taxable income (modified adjusted gross income, for individual taxpayers), excluding the DPD.

Qualified production activities eligible for the DPD include items such as:  the manufacture, production, growth or extraction of qualifying production property by a taxpayer in the U.S.; construction or substantial renovation of real property in the U.S.; and engineering and architectural services performed in the U.S. relating to the construction of real property.

The DPD can't exceed 50% of the applicable W-2 wages of the employer for the tax year.  The wages must be allocable to the taxpayer's domestic production activities, and they include tips and other compensation as well as elective deferrals to 401(k) and other plans. 

The DPD for oil-related activity is subject to a special reduction to QPAI.

It is important for businesses to calculate the tentative DPD and the W-2 deduction cap before year-end.  If the wage deduction cap will limit the otherwise available deduction, the business may want to pay or accrue additional compensation to maximize the DPD (for example, in the case of a closely held business whose owners do not draw substantial salaries).

Properly allocating expenses in determining QPAI is important. If activities don’t impact QPAI, the expenses related to the activity should not be allocated to QPAI. It’s worth spending time analyzing your activities and following the expense allocation rules which can be complex; it could increase the 9% DPD.

Also, if certain amounts are being paid to owners of pass-through entities (S-Corporations, Partnerships and LLCs), such as interest, rents, compensation; reducing these amounts generally has no impact on taxable income, but may increase QPAI thereby increasing the DPD.

The lesson is, don’t wait until tax preparation time to review your QPAI, review it before year end and determine how you can maximize QPAI and avoid the taxable income and wage limitation.

Holiday Kick-off Weekend

What an awesome Thanksgiving day and weekend. The  Christmas season is here. What a great time of year. My family loves it. This year our soldier son will join us. That is special. Time to get in the mood. Go get your tree. I can’t wait to hang up my Internal Revenue Code ornament.

Self-Employed Health Insurance Deduction - Make Applicable Reimbursements by Year End

Section 162(l) allows the following to deduct premiums paid for medical, dental and qualified long-term care insurance covering the owner and his or her spouse, dependents and children under age 27:  Self-Employed Persons; Partners of a partnership; LLC members of LLCs taxed as partnerships; and more than 2% owners of S-corporations and LLCs taxed as S-corporations.

Medical insurance includes voluntary Medicare premiums for the taxpayer, the spouse and the dependents.  However, see below for rules relating to insurance plans and required reimbursements by certain employers if the employer doesn’t remit the payments to the insurance company or Medicare.

This is  a change in position by the IRS. In the past, the IRS indicated no Medicare premiums were deductible under Section 162(l). Now, only Medicare Part  A mandatory payments don’t qualify for the deduction. This is a refund opportunity for taxpayers who did not deduct Voluntary Medicare Premiums under this rule in the past. Amended returns should be filed to claim the refund.

The deduction is limited to the earned income generated by the owner from the applicable business. The deduction is taken on page one of Form 1040 before Adjusted Gross Income (i.e. above the line), not as an itemized deduction subject to phase outs and alternative minimum tax adjustments. The insurance must be part of a plan established by the applicable business. The insurance can be either in the name of the business or the taxpayer. The premium payments can be paid by the business or by the individual participating in the plan. For Partners, LLC members and S-corporation shareholders, if the premium is paid by the owner, the partnership, LLC or S-Corporation must reimburse them for the premium.

S-corporation’s deduct the premium and must report the amount on the owners W-2 Form. Partnerships and LLCs treat it the same, but add the premium to the partners or members guaranteed payments (similar to wages).  The owners deduct the premiums reported on the W-2 or as guaranteed payments on their individual  tax return.

Each business should have a written plan detailing the coverage, including Medicare premiums; who is paying the premiums to the insurance company and Medicare; and the reimbursement policy, if paid by the owner.

WARNING-If the owners are responsible for remitting the premiums directly to the insurance company and the business is an S-corporation, partnership or LLC , make sure they get reimbursed by year end. Otherwise a perfectly legitimate deduction will be lost.

Happy Thanksgiving

I hope everyone has a wonderful Thanksgiving. It is one of my favorite holidays-Family, Food and Football. You can’t beat it. I will be at the boat house condo swimming in the indoor pool and eating Thanksgiving dinner with Patrick, Cami, Max, Keira, Jimmy, Vinny and Jack. My seven grandchildren. I can’t wait.

I may even take a day off from reading tax information. No, I don’t think I so.