The IRS has released much-anticipated temporary and proposed regulations on the capitalization of costs incurred for tangible property. They impact how virtually any business writes off costs that repair, maintain, improve or replace any tangible property used in the business, from office furniture to roof repairs to photocopy maintenance and everything in between. They apply immediately, to tax years beginning on or after January 1, 2012.

The IRS has released much-anticipated temporary and proposed regulations on the capitalization of costs incurred for tangible property. They impact how virtually any business writes off costs that repair, maintain, improve or replace any tangible property used in the business, from office furniture to roof repairs to photocopy maintenance and everything in between. They apply immediately, to tax years beginning on or after January 1, 2012.

These so-called “repair regulations” are broad and comprehensive. They apply not only to repairs, but to the capitalization of amounts paid to acquire, produce or improve tangible property. They are intended to clarify and expand existing regulations, set out some bright-line tests, and provide some safe harbors for deducting payments.

The regulations are an ambitious effort to address capitalization of specific expenses associated with tangible property. The regulations affect manufacturers, wholesalers, distributors, and retailers—everyone who uses tangible property, whether the property is owned or leased. The rules provide a more defined framework for determining capital expenditures.

Most taxpayers will have to make changes to their method of accounting to comply with the temporary regulations and will need to file Form 3115. Taxpayers who filed for a change of accounting method following the issuance of the 2008 proposed regulations will probably have to change their accounting method again.

The IRS has promised to issue two revenue procedures that will provide transition rules for taxpayers changing their method of accounting, including the granting of automatic consent to make the change. The regulations require taxpayers to make a Code Sec. 481(a) adjustment; this means that taxpayers will have to apply the regulations to costs incurred both prior to and after the effective date of the regulations.

The new regulations provide rules for materials and supplies that can be deducted, rather than capitalized. The rules provide several methods of accounting for rotable and temporary spare parts, and allow taxpayers to apply a de minimis rule so that they can deduct materials and supplies when they are purchased, not when they are consumed.

Costs to acquire, produce or improve tangible property must be capitalized. The regulations address moving and reinstallation costs, work performed prior to placing property into service, and transaction costs. Generally, costs of simply removing property can be deducted, but costs of moving and then reinstalling property may have to be capitalized.

To determine whether a cost incurred for property is an improvement, it is necessary to determine the unit of property. Generally, the larger the unit of property, the easier it is to deduct expenses, rather than have to capitalize them. The regulations provide detailed rules for determining the unit of property for buildings and for non-building tangible property. For buildings, the IRS identified eight component systems as separate units of property, requiring more costs to be capitalized. However, the new rules also provide for deducting the costs of property taken out of service, by treating the retirement as a disposition.

The new regulations require virtually every business to review how repairs, maintenance, improvements and replacements are handled for tax purposes, with both mandatory and optional adjustments made to past treatment as appropriate.

Please feel free to call this office for a more targeted explanation of how these new regulations impact your business operations.

The fate of the employee-side payroll tax cut along with a host of tax extenders and other expired provisions could be decided in coming weeks. A conference committee of House and Senate members is negotiating a full-year extension of the payroll tax cut and could add some or all of the tax extenders to a final package. Lawmakers also could extend the payroll tax cut without acting on any tax incentives.

The fate of the employee-side payroll tax cut along with a host of tax extenders and other expired provisions could be decided in coming weeks. A conference committee of House and Senate members is negotiating a full-year extension of the payroll tax cut and could add some or all of the tax extenders to a final package. Lawmakers also could extend the payroll tax cut without acting on any tax incentives.

Payroll tax cut

The Temporary Payroll Tax Cut Continuation Act of 2011 extended the employee-side OASDI tax cut through the end of February 2012. The employee-share of OASDI taxes is 4.2 percent for the two-month period, rather than 6.2 percent. The employer-share of OASDI taxes remains at 6.2 percent for the two month period. Self-employed individuals also benefit from a two percentage point reduction in OASDI taxes.

Unless extended, the employee-share of OASDI taxes is scheduled to revert to 6.2 percent after February 29, 2012. The White House and the leaders of the two parties in Congress agree that the payroll tax cut should be extended a full-year. They disagree, however, how to pay for the extension; even if it should be paid for at all.

Congress could extend the two-month payroll tax cut through the end of 2012 without paying for it. The 2011 payroll tax cut was unfunded. Congress appropriated to the Social Security trust funds amounts equal to the reduction in payroll tax revenues. The 2011 payroll tax cut was estimated by the Congressional Budget Office cost approximately $111 billion. Extending it through the end of 2012 is estimated to cost just as much if not more.

House Republicans reportedly have proposed a number of revenue raisers to offset the cost of extending the payroll tax cut through the end of 2012. One GOP proposal would extend the current pay freeze for employees of the federal government. Another GOP proposal would require higher-income individuals to pay increased Medicare premiums.

One possible revenue raiser, increasingly under discussion by Democrats, is a change in the taxation of so-called carried interest. Current law generally taxes carried interest as capital gains and not as ordinary income. Past efforts to change the tax treatment of carried interest have failed to pass Congress.

Extenders

The so-called tax extenders, popular but temporary tax provisions, expired at the end of 2011. Many taxpayers are surprised to learn that their particular tax break, whether it be the state or local sales tax deduction, the teachers’ classroom expense deduction, or the research tax credit, are temporary. The extenders have been routinely revived many times in the past. This year, however, could be different. Faced with record federal budget deficits, lawmakers may decide to extend only some of the expired provisions.

President Obama’s FY 2013 proposals

President Obama is expected to release his fiscal year (FY) 2013 federal budget proposals in early February, which will reignite debate over the Bush-era tax cuts. President Obama is expected to urge Congress to allow the Bush-era tax cuts to expire after 2012 for higher-income taxpayers, which President Obama defines as individuals earning more than $200,000 or families earning more than $250,000. In recent weeks, there has been speculation that President Obama may revisit those definitions in his FY 2013 budget, possibly raising the amounts.

Few Capitol Hill observers expect Congress to take any action on the Bush-era tax cuts before the November elections. Instead, Congress may take up some of President Obama’s other proposals. As in past budgets, President Obama will likely propose to extend some energy tax breaks for individuals and businesses, extend tax incentives for education and provide some targeted-tax breaks to businesses. President Obama has also promised to introduce proposals to encourage U.S. companies to “insource” jobs at home.

On some issues, such as energy and education, lawmakers may find common ground but negotiations are likely to go down to the wire. Our office will keep you posted of developments.

If you have any questions about the payroll tax cut, tax extenders or the various tax proposals under discussion, please contact our office.

The IRS reopened its offshore voluntary disclosure program in early 2012 in response to what the government described as strong interest among taxpayers. The reopened program, the third of its type in recent years, encourages taxpayers with unreported foreign accounts to make full disclosures in exchange for a reduced penalty framework. Like its predecessors, the terms and conditions of the reopened program are very complex. The IRS has promised to provide more details. In the meantime, the prior offshore disclosure programs are guides to how the IRS intends to implement the third, reopened program.

The IRS reopened its offshore voluntary disclosure program in early 2012 in response to what the government described as strong interest among taxpayers. The reopened program, the third of its type in recent years, encourages taxpayers with unreported foreign accounts to make full disclosures in exchange for a reduced penalty framework. Like its predecessors, the terms and conditions of the reopened program are very complex. The IRS has promised to provide more details. In the meantime, the prior offshore disclosure programs are guides to how the IRS intends to implement the third, reopened program.

Previous disclosure programs

The IRS launched two previous offshore disclosure initiatives: one in 2009 and another in 2011. Both programs offered reduced penalties in exchange for full disclosure. In early 2012, the IRS reported it received 33,000 voluntary disclosures from the 2009 and 2011 offshore initiatives. The government has collected over $4.4 billion from the 2009 and 2011 programs. The IRS predicted it will collect more revenue as it continues to work cases.

Reopened program

The reopened program operates very similarly to the 2009 and 2011 programs but with some key differences. The previous programs were temporary. The 2011 program ended in mid-September 2011. The reopened program has no set end date. The IRS cautioned, however, that it could close the program at some future date. The decision to end the program is solely at the discretion of the IRS.

The reopened program requires taxpayers to file all original and amended tax returns and include payment for back-taxes and interest for up to eight years as well as pay accuracy-related and/or delinquency penalties. Additionally, taxpayers must pay a penalty of 27.5 percent of the highest aggregate balance in foreign bank accounts/entities or value of foreign assets during the eight full tax years prior to the disclosure. In comparison, the highest penalty in the 2011 program was 25 percent. IRS officials have said that the penalty was increased because the agency does not want to reward taxpayers who did not participate in the 2009 or 2011 disclosure programs because they anticipated that a future penalty would be lower.

In limited circumstances, taxpayers may qualify for a 12.5 percent penalty or a five percent penalty. Generally, taxpayers whose offshore accounts or assets did not surpass $75,000 in any calendar year may qualify for the 12.5 percent penalty.

The requirements for the five percent penalty are very narrow. The IRS has explained that taxpayers must meet four conditions: (1) The taxpayer did not open or cause the account to be opened; (2) the taxpayer exercised minimal, infrequent contact with the account, for example, to request the account balance, or update account holder information such as a change in address, contact person, or email address; (3) except for a withdrawal closing the account and transferring the funds to an account in the United States, the taxpayer did not withdraw more than $1,000 from the account in any year for which the taxpayer was non-compliant; and (4) the taxpayer can show that all applicable U.S. taxes have been paid on funds deposited to the account (only account earnings have escaped U.S. taxation).

The penalty amounts in the reopened program are not set in stone, the IRS cautioned. It may eventually increase penalties in the program for all or some taxpayers or defined classes of taxpayers.

Quiet disclosures

One goal of the three programs is to caution taxpayers against so-called “quiet disclosures.” A quiet disclosure occurs when a taxpayer files an amended return and pays any tax delinquency without making a formal voluntary disclosure. The IRS warned taxpayers making quiet disclosures that they risked being sanctioned to the fullest extent allowed by law.

Critics

The offshore disclosure programs were not without their critics. The National Taxpayer Advocate recently told Congress that the IRS should streamline what is a very complicated process. The National Taxpayer Advocate also reported that IRS examiners were assuming that all violations were willful unless a taxpayer presented evidence to the contrary. It is possible that the IRS may revisit some of the terms and conditions of the reopened program in light of the National Taxpayer Advocate’s report.

If you have any questions about the reopened offshore voluntary disclosure program, please contact our office.

Taxpayers with children should be aware of the numerous tax breaks for which they may qualify. Among them are: the dependency exemption, child tax credit, child care credit, and adoption credit. As they get older, education tax credits for higher education may be available; as is a new tax code requirement for employer-sponsored health care to cover young adults up to age 26. Employers of parents with young children may also qualify for the child care assistance credit.

Taxpayers with children should be aware of the numerous tax breaks for which they may qualify. Among them are: the dependency exemption, child tax credit, child care credit, and adoption credit. As they get older, education tax credits for higher education may be available; as is a new tax code requirement for employer-sponsored health care to cover young adults up to age 26. Employers of parents with young children may also qualify for the child care assistance credit.

Dependency Exemption

In addition to the personal exemption an individual taxpayer may take for him or herself to reduce taxable income (Line 42 on Form 1040), that taxpayer may also take an exemption for each qualifying dependent who has lived with the taxpayer for more than half of the tax year. A dependent may be a natural child, step-child, step-sibling, half-sibling, adopted child, eligible foster child, or grandchild, and generally must be under age 19, a full-time student under age 24, or have special needs. The amount of the exemption is the same as the taxpayer’s personal exemption, $3,700 for the 2011 tax year and $3,800 for the 2012 tax year.

Child Tax Credit

Parents of children who are under age 17 at the end of the tax year may qualify for a refundable $1,000 tax credit. The credit is a dollar-for-dollar reduction of tax liability, and may be listed on Line 51 of Form 1040. For every $1,000 of adjusted gross income above the threshold limit ($110,000 for married joint filers; $75,000 for single filers), the amount of the credit decreases by $50.

Child and Dependent Care Credit

If a taxpayer must pay for childcare for a child under age 13 in order to pursue or maintain gainful employment, he or she may claim up to $3,000 of his or her eligible expenses for dependent care. If one parent stays home full-time, however, no child care costs are eligible for the credit.

Adoption Credit

Taxpayers who have incurred qualified adoption expenses in 2011 may claim either a $13,360 credit against tax owed or a $13,360 income exclusion if the taxpayer has received payments or reimbursements from his or her employer for adoption expenses. For 2012, the amount of the credit will decrease to $12,650, and in 2013 to $5,000.

Higher Education Credits

There are two education-related credits available for 2012: the American Opportunity credit and the lifetime learning credit. The American Opportunity credit amount is the sum of 100 percent of the first $2,000 of qualified tuition and related expenses plus 25 percent of the next $2,000 of qualified tuition and related expenses, for a total maximum credit of $2,500 per eligible student per year. The credit is available for the first four years of a student's post-secondary education. The credit amount phases out ratably for taxpayers with modified AGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers). The lifetime learning credit is equal to 20 percent of the amount of qualified tuition expenses paid on the first $10,000 of tuition per family. The phaseout for 2012 ranges from $52,000 to $62,000 ($104,000 to $124,000 for joint filers). Parents also find tax relief in saving for college though Coverdell accounts, section 529 plans and specified U.S.. savings bonds.

Extended Health Care Coverage

Effective since September 23, 2010, the new health care law requires plans to provide coverage for children until they attain age 26. Further, effective on or after March 30, 2010, children under the age of 27 are considered dependents of a taxpayer for purposes of the general exclusion from income for reimbursements for medical care expenses of an employee, spouse, and dependents under an employer-provided accident or health plan. Therefore, a plan must provide coverage to a child who is still a dependent up to age 26; but can do so up to age 27 without income tax consequences. A child includes a son, daughter, stepson, or stepdaughter of the taxpayer; a foster child placed with the taxpayer by an authorized placement agency or by judgment, decree, or other order of any court of competent jurisdiction; and a legally adopted child of the taxpayer or a child who has been lawfully placed with the taxpayer for legal adoption.

Child Care Assistance Credit (for businesses)

Employers may take up to $150,000 of the eligible costs of providing employees with child care assistance as tax credit. These costs may include a portion of the costs of acquiring, constructing, improving, and operating a child care facility.

If you have any questions about these provisions and how they may benefit you, please contact our office.

The Treasury Department is authorized to offset a taxpayer’s tax refund to satisfy certain debts. A spouse who believes that his or her portion of the refund should not be used to offset the debt that the other spouse owes may request a refund from the IRS.

The Treasury Department is authorized to offset a taxpayer’s tax refund to satisfy certain debts. A spouse who believes that his or her portion of the refund should not be used to offset the debt that the other spouse owes may request a refund from the IRS.

Offset

If an individual owes money to the federal government because of a delinquent debt, the Treasury Department’s Financial Management Service (FMS) can offset that individual's tax refund (and certain other federal payments) to satisfy the debt. The debtor will be notified in advance of the offset.

A taxpayer’s refund may be reduced by FMS and offset to pay:

• Past-due child support
• Federal agency non-tax debts
• State income tax obligations, or
• Certain unemployment compensation debts owed a state.

FMS advises taxpayers by written notice of an offset. FMS has explained that the notice will reflect the original refund amount, the taxpayer’s offset amount, the agency receiving the payment, and the address and telephone number of the agency. FMS will notify the IRS of the amount taken from your refund.

Form 8379

If a taxpayer filed a joint return and is not responsible for the debt of his or her spouse, the taxpayer may request his or her portion of the refund by filing Form 8379, Injured Spouse Allocation, with the IRS. Form 8379 may be filed with the original return or by itself after the taxpayer is aware of the offset.

The IRS has instructed taxpayers filing Form 8379 by itself to attach a copy of all Forms W-2 and W-2G for both spouses, and any Forms 1099 showing federal income tax withholding to Form 8379. Failure to attach these items may result in a delay in processing by the IRS.

The IRS has reported on its website that it generally processes Forms 8379 that are filed after a joint return has been filed in approximately eight weeks. The timeframe for processing a Form 8379 that is attached to a joint return is approximately 11 weeks (14 weeks if the joint return is filed on paper).

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 February 2012.

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 February 2012.

February 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 25–27.

February 3

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 28–31.

February 8

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 1–3.

February 10

Employees who work for tips. Employees who received $20 or more in tips during November must report them to their employer using Form 4070.

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 4–7.

February 15

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 8–10.

Monthly depositors. Monthly depositors must deposit employment taxes for payments in January.

February 17

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 11–14.

February 23

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 15–17.

February 24

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 18–21.

February 29

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 22–24.

March 2

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 25–28.

March 7

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 29–March 2.

A compendium of Tax Law Changes that are effective for 2011 and 2012. And reminders of changes made in prior years.

Payroll Tax Forms   The IRS no longer provides annual or quarterly payroll tax forms to employers and California EDD no longer has annual Form DE7.

California new hire reporting   Effective January 1, 2012, California requires employers to give written notice to non-exempt new hires regarding the terms of their employment. The required “Notice to Employee” form is included in this packet (if you are receiving the e-organizer, you will receive the form in a separate email as an attachment). Employers must also report new hires to the EDD using Form DE 34. Independent contractors who receive $600 or more in payments each year must be reported using Form DE 542. Penalties may be assessed for failure to report new hires.

Sales of stock and securities   If you sold stock or securities through a broker, the broker will issue you a 1099-B. This form is now intended to report all details of each sale including the sales price and cost basis. Please be sure to provide us with copies of any 1099-Bs you receive as they contain pertinent information for reporting capital gains and losses.

Merchant charges, 1099-Ks   Beginning in 2011, a new form (Form 1099-K) will be issued to businesses that accept credit card payments or use third party payment networks (such as PayPal) for more than 200 transactions and $20,000 in gross income. In 2012, sales figures will need to be reported separately, on two separate lines; one for merchant cards and third party payments and the other for cash and check payments. You will need to start tracking payments by type beginning in January, 2012.

Foreign accounts   The reporting requirements for assets held overseas are increasing and the penalties for failure to report them are becoming increasingly harsh. Not all foreign holdings must be reported. If, for example, you hold stock in a foreign company through a U.S. broker, those holdings do not have to be separately reported. However, if you hold any other types of foreign assets, including bank accounts and securities accounts, they may need to be reported.

Property tax statements   The Franchise Tax Board has stated that they will begin requiring parcel numbers and other information pertaining to property taxes for any taxpayer who deducts property tax as an itemized deduction. Although the requirement isn’t slated to take effect until 2012, it is a good idea to provide us with these statements now.

Current tax rates   have been extended through 2012, with a top rate of 35% for ordinary income and 15% for capital gains.  The capital gains rates are 0% (no tax) and 15% for assets held for over one year and for qualified dividends.  The 0% rate applies only to the extent that adjusted net capital gains would be taxed at 10% or 15% if it were ordinary income.  Otherwise, adjusted net capital gains are taxed at 15%.

Payroll tax cut   The Temporary Payroll Tax Cut Continuation Act of 2011 temporarily extends the 2% reduction in Social Security tax for employees through February 29, 2012.

FUTA surtax and credit reduction   There will be two changes to Form 940 for tax year 2011. First, the 0.2% FUTA surtax expired on June 30, 2011; therefore, the base FUTA rate is 6.2% for the first half of 2011 and 6.0% for the second half. Second, California employers will be required to pay a 0.3% increase in FUTA tax since California is now a credit reduction state as a result of its outstanding federal loans to pay unemployment benefits. Employers will use Form 940 (Schedule A) to calculate the credit reduction.

Information Reporting for Rental Properties   Under the Small Business Jobs Act of 2010, landlords were going to be required to file 1099s for payments of $600 or more to each service-provider beginning in 2011. However, Congress has since passed H.R. 4, which repeals the 1099 reporting requirement for landlords and they will not be required to issue 1099s.

Estate tax   The 2010 Tax Relief Act reinstated the estate tax for deaths after January 1, 2010 and before January 1, 2013. Under the new law, the maximum estate tax rate for 2011 and 2012 is 35%, with an exclusion amount of $5 million ($5,120,000 for 2012 due to inflation). For deaths in 2011 and 2012, the estate of a surviving spouse may qualify to use the unused exclusion amount of their predeceased spouse. The Act also increases the exclusion amounts for lifetime gifts and GSTs to $5 million.

Credit for retained workers   Employers may qualify for a credit of up to $1,000 if they hired an employee between February 4, 2010 and December 31, 2010 and that employee was retained for at least 52 weeks. The credit is equal to the lesser of $1,000 or 6.2% of the worker’s wages during the 52-consecutive-week period. All qualifying employees will reach their qualifying date in 2011 and calendar-year employers will claim the credit on their 2011 returns.

Small Business Health Care Tax Credit   is specifically targeted to help small employers that primarily employ low and moderate income workers.  To qualify, the number of full-time workers in the business must be 25 or less and the average wages must be less than $50,000 per year.  For tax years 2010 to 2013, the maximum credit is 35%, which phases out when the employer has 10 or more employees and the average full time wages are over $25,000.

Credit for non-business energy property   For 2011, a tax credit equal to 10% of the cost of energy efficient improvements to a principal residence is allowed. There are certain dollar limitations on each type of improvement and a lifetime limitation of $500 for the credit.

Bonus depreciation and §179 business expensing   Bonus depreciation allows businesses to expense 100% of certain equipment purchased after September 8, 2010, and before January 1, 2012.  The allowable §179 for 2011 is $500,000 with a phase-out threshold amount of $2 million. For 2012 the §179 limit is reduced to $125,000 ($139,000 adjusted for inflation).

California New Jobs Credit   provides a credit of up to $3,000 for each net increase in qualified full-time employees hired by a small business during the taxable year.  For purposes of the credit, a small business is one that had 20 or fewer employees on the last day of the previous taxable year.  There is a $400 million cap on the credit.  As of 12/19/11, only $70 million of the credit has been claimed.  

California Use Tax   Many businesses that do not currently hold a seller’s permit are required to register with the Board of Equalization, and report and pay, by April 15, any use tax due from purchases made in the preceding year.  However, the deadline to file the 2011 Use Tax Return is on April 17, 2012.  Use tax applies to purchases from out-of state vendors that are not required to collect tax on their sales.  This applies to purchases over the internet and brought in to be used in California. For tax years beginning on or after January 1, 2011, taxpayers may elect to report use tax for single nonbusiness purchases of $1,000 or less using the actual amount of tax due or the amount shown on a lookup table, which is based on AGI rather than actual receipts.

State Sales Tax Deduction   has been extended through 2011. This is available as an alternative to the state and local income tax deduction for individual federal tax returns.  You can deduct the largest of: (1) your actual sales taxes paid, (2) amounts from IRS tables plus sales taxes paid for home (major renovations or materials), autos, boats and airplanes, or (3) your state income tax paid.

Computer Purchases can be paid for by a Qualified Tuition Plan   Computer equipment and technology is included on the list of college expenses that can be paid for by a 529 college plan.  To qualify the beneficiary must use the technology, equipment or services while enrolled at an eligible educational institution.  

Tightening of Rules relating to the Gain from Sale of Personal Residence   Under present law, you may exclude up to $250,000 ($500,000 for married filing joint) of the gain from the sale of a personal residence if you have lived in that home for 2 of the past 5 years.  The gain from the sale will not be excluded for periods that the home was not used as a principal residence after January 1, 2009.

Mortgage Forgiveness Debt Relief Act   In general, income from the discharge of debt is includable in income.  With many people’s homes being foreclosed or sold as a short sale, this could become a problem.  Under this Act, taxpayers may exclude up to $2 million of income from the discharge of indebtedness where the debt was non-recourse and secured by the taxpayer’s principal residence. The debt must be the original debt incurred at the time of purchase.  The Act covers the period from 2007 through 2012.  California does not conform to federal law on Cancellation of Debt income, but does conform to the insolvency provisions.

Tax Credit for First-time Homebuyers   The first-time homebuyer credit expired in 2010. Taxpayers who purchased a home after 2008 and claimed the credit do not have to recapture it unless the home was disposed of or the home ceases to be their main home during the 36- month period beginning on the purchase date of the home. Taxpayers who purchased a home in 2008 must recapture the credit over a 15-year period beginning two years after the purchase date. If the home is sold or ceases to be the main home before the end of the 15-year recapture period then the remaining credit amount is repaid during the year the home ceases to be the principal residence. For taxpayers who sell their home, the recapture amount is the lesser of the credit repayment or the gain on the sale.

California Estimated Tax Payments   are still accelerated for 2012, for individuals and corporations by requiring the first payment to be 30%, the second payment is 40%, the third payment is 0% and the fourth payment is 30% of the “required annual payment.”  The “required annual payment” is 90% of the tax shown on the return or 100% of the tax shown on the previous year’s return (110% if the prior year’s adjusted gross income (AGI) exceeds $150,000).  However, taxpayers with AGI in excess of $1 million must pay at least 90% of their current year tax; there is no 110% prior year safe harbor.  Federal estimated payments have not changed.

The Required Minimum Distribution (RMD) Excise Tax   Individuals who have reached age 70½ must take a required minimum distribution annually from their retirement account.  Failure to take the distribution subjects the individual to a tax equal to 50% of the amount that should have been withdrawn.  Instead of taking distributions, individuals may elect to transfer their distributions, tax-free up to $100,000 per year, to eligible charitable organizations.  

Traditional IRA Contributions   are deductible up to $5,000 or $6,000 if you are 50 or older.  As before, deductions are limited for taxpayers covered by employer plans, depending on their AGI.  For married taxpayers filing jointly who both participate in employer plans, the deduction phases out where modified AGI is between $90,000 - $110,000 ($56,000 to $66,000 for single or head of household taxpayers). Where only the taxpayer's jointly filing spouse is covered by a plan, the phase out is between $169,000 and $179,000 of modified AGI. For 2012 the contribution limits stay the same at $5,000, or $6,000 if you are 50 or older.

$ 5,000 Roth IRAs    ($6,000 if you are 50 or older) are available even if you are covered by an employer plan with the same restrictions listed above for traditional IRA.  However, AGI limitations will phase out of participation at $107,000 to $122,000 for singles, $169,000 to $179,000 for joint filers and $0 to $10,000 for married filing separately.  Most states have adopted these new limits.  For 2012, the contribution limits stay the same at $5,000 or $6,000 if you are 50 or older.

Traditional IRA conversions to Roth IRAs   You can still convert your traditional IRA to a Roth IRA at any time; however you must pay taxes on the entire amount of the IRA accounts converted.  With the stock market down, this could work to your advantage.  If your portfolio is down 30%, you avoid paying taxes on that 30% of lost value.  For example, if you had $100,000 in a traditional IRA and it’s down 30% to $70,000, you would pay taxes on $70,000 instead of $100,000 when converting.  Any rebound and future appreciation is all tax-free when taken out as a qualified distribution.

Tax-Free IRA Distributions to Charity   This is extended through 2011. Under this provision, an individual who is at least 70½ years old can request the IRA trustee to make a direct transfer of IRA funds, up to $100,000, to a qualified charity. The amount distributed is not included as income and not deductible as a charitable contribution. For those wishing to make charitable contributions, this is a tax-efficient way to take a required minimum distribution.

Enhanced Alternative Minimum Tax (AMT) exemption amounts for 2011   AMT exemption amounts are increased for 2011. They are $74,450 for married filing jointly, $48,450 for single or head of household and $37,225 for married filing separately.  One factor that contributes to having to pay AMT is to live in a state with a high income tax rate, which includes California.  

Standard Auto Mileage   The 2011 business rate is $0.51 through June 30, 2011 and $0.56 July 1, 2011 through December 31, 2011. Medical and moving mileage rates for the first half of 2011 are $0.19 and $0.24 for the second half of the year.  Charity rates remain at $0.14 for 2011.

The American Opportunity Tax Credit   The credit is 100% of the first $2,000 and 25% of the next $2,000 of tuition, enrollment fees and course materials incurred in the first four years of college.  The credit phases out for singles with income between $80,000 and $90,000 and joint filers between $160,000 and $180,000.  Up to 40% of the taxpayers’ modified credit may be refundable.  The Lifetime Learning Credit is available for any year of undergraduate or graduate enrollment where the American Opportunity Tax Credit is not available.  The maximum credit is 20% of the first $10,000 of tuition and enrollment fees. The credit is phased out for singles with income between $51,000 and $61,000 and joint filers between $102,000 and $122,000. Neither credit is available for married taxpayers filing separate returns.

Tuition and Fees Deduction   If your income level precludes you from claiming the Lifetime Learning Credit, then you may qualify for the Tuition and Fees deduction.  For 2011 a $4,000 deduction is available when adjusted gross income is no more than $65,000 for singles and $130,000 for joint returns.  A reduced deduction of $2,000 may apply for modified AGI between $65,000 - $80,000 for singles and $130,000 - $160,000 for joint returns. Neither credit is available for married taxpayers filing separate returns or for someone claimed as another taxpayer’s dependent. The tuition deduction expires after December 31, 2011.

Children under 19 years   who receive taxable investment income may need to calculate tax using their parent’s higher tax rates on their 2011 returns (prior to 2006 this “kiddie tax” applied to children under 14 years, which it still does in California).  The amount of taxable investment income a child can have without being taxed at the parent’s rate is $1,900.  The “kiddie tax” also applies to children who are full-time students age 19-23 and did not have earned income that was more than half their support.  

Charitable contributions   Clothing and Household Items are not deductible unless the donated items are in “good” or better condition.  An exception would be items worth $500 or more and accompanied by an appraisal.  Cash donations have stricter written substantiation rules.  These rules include external documentation of the contribution such as; bank records, written communications, receipt from the charitable organization with date of donation, and amount contributed.  Contribution by payroll deduction – retain a pay stub, copy of pledge card, other documents that list the charitable organization.

Child tax credits   of $1,000 per dependent child under 17 are available if adjusted gross income is less than $110,000 for joint filers, $75,000 for singles or heads of household and $55,000 for married filing separately.  As income exceeds these levels the credit is reduced.  The refundable portion of the credit is 15% of earned income over $3,000 for 2011.

Annual gifts   of $13,000 per donee are not subject to gift taxes.  The limits are $26,000 per donee if spouses elect gift splitting.

Electronic Funds Transfer Penalties   California tax law requires any individuals who made a single California estimated tax payment or extension payment greater than $20,000 or filed an original tax return with a tax liability greater than $80,000 for any tax years beginning on or after January 1, 2009 to make all tax payments electronically.  The penalty for failing to pay electronically is 1% of the payment. Individuals who meet the above requirements under unusual circumstances may request for a waiver to be excluded from making electronic payments.


Please contact our office if you have any questions regarding these or other tax issues or financial planning matters.

The typical discussion about employing your spouse revolves around are you better off paying payroll taxes in order to get an additional retirement plan contribution and the related tax deduction? Based on the type of retirement plan you have the answer can vary.

In this article, Dennis explores the benefits of employing spouses and family members in a business:

Should You Employ Your Spouse, Your Child and Claim Other Deductions?

The typical discussion about employing your spouse revolves around are you better off paying payroll taxes in order to get an additional retirement plan contribution and the related tax deduction? Based on the type of retirement plan you have the answer can vary. The payroll taxes will be close to 16%, the retirement contribution by you, the employer, can be 25% (or more if you have a defined benefit plan) plus the working spouse can defer wages if you have a 401K or SIMPLE. Generally, if you have some form of retirement plan the business owner is better off employing his or her spouse.

Business Trips

However, regardless of whether the owner has a retirement plan, there is a much more compelling reason to hire your spouse. In order to deduct the cost of your spouse accompanying you on a business trip or entertainment outing, the IRS requires that your spouse must be an employee of your practice. Whether it's a dinner with a colleague, the annual shareholder/strategic planning meeting in Maui or the host of other activities your spouse attends with you, your spouse must be your employee if you plan on deducting the cost of your escort. The amount of compensation is less important than the employment relationship.

Documentation

In real estate you always hear "location, location, location", in the tax world it's "documentation, documentation, documentation". Often I'm asked: "Is it a red flag?" "Will it cause an audit?" The incidence of tax audits is increasing. I believe the question should not be will it cause an audit, but rather will I prevail if I am audited, because statistically you will be audited, eventually.

If you want to deduct the cost of a business car, document your business usage. If you want to write off your entertainment, make sure you keep records of:

1. Who you were with,
2. Where you went,
3. What you talked about,
4. When you went and, of course,
5. How much did you spend.

Having boxes full of restaurant receipts will mean nothing unless you have documented these five items. If you use credit cards, just write down who and what for on the back of the receipt, the other three items are already documented. If the expenditure was $75 or less, you don't need a receipt, just write down the five pieces of information.

Agendas

That trip to Maui (or anyplace in the United States) can be deducted, but you'll need records. The IRS deems a business day is five hours or more. Make an agenda of your business discussions and meetings that will justify five hours or more each day. If the reason for the trip is business (have a good agenda) the whole cost could be deducted. But if the reason is pleasure, only the actual business expenses you incur would be deductible, not the lodging or transportation costs.

Should you hire your children?

If you document their job descriptions, your dependents could be earning their college funds and you could get a tax deduction for their education. If you're self employed, you can even avoid paying payroll taxes.

The form of documentation is not prescribed by the IRS. It does not have to be fancy. You should develop a method of documentation that is simple, yet adequate, and commit to making it a habit. Too busy? Assign a staff member to create the document from the information you provide. Don't worry about an audit, prepare for it.

Have a question? Please call me and ask.

Dennis Nelson, CPA, APC has served the Sacramento Area dental community since 1991. He can be reached at 919-988-8583.