The IRS issued frequently asked questions (FAQs) addressing the new deduction for qualified overtime compensation added by the One, Big, Beautiful Bill Act (OBBBA). The FAQs provide general information to taxpayers and tax professionals on eligibility for the deduction and how the deduction is determined.

The IRS issued frequently asked questions (FAQs) addressing the new deduction for qualified overtime compensation added by the One, Big, Beautiful Bill Act (OBBBA). The FAQs provide general information to taxpayers and tax professionals on eligibility for the deduction and how the deduction is determined.

General Information

The FAQs explain what constitutes qualified overtime compensation for purposes of the deduction, including overtime compensation required under section 7 of the Fair Labor Standards Act (FLSA) that exceeds an employee’s regular rate of pay. The FAQs also describe which individuals are covered by and not exempt from the FLSA overtime requirements.

FLSA Overtime Eligibility

The FAQs address how individuals, including federal employees, can determine whether they are FLSA overtime-eligible. For federal employees, eligibility is generally reflected on Standard Form 50 and administered by the Office of Personnel Management, subject to certain exceptions.

Deduction Amount and Limits

The FAQs explain that the deduction is limited to a maximum amount of qualified overtime compensation per return and is subject to phase-out based on modified adjusted gross income. Special filing and identification requirements also apply to claim the deduction.

Reporting and Calculation Rules

The FAQs describe how qualified overtime compensation is reported for tax purposes, including special reporting rules for tax year 2025 and required separate reporting by employers for tax years 2026 and later. The FAQs also outline methods taxpayers may use to calculate the deduction if separate reporting is not provided.

FS-2026-1

IR 2026-10

Proposed regulations regarding the deduction for qualified passenger vehicle loan interest (QPVLI) and the information reporting requirements for the receipt of interest on a specified passenger vehicle loan (SPVL), Code Sec. 163(h)(4), as added by the One Big Beautiful Bill Act (P.L. 119-21), provides that for tax years beginning after December 31, 2024, and before January 1, 2029, personal interest does not include QPVLI. Code Sec. 6050AA provides that any person engaged in a trade or business who, in the course of that trade or business, receives interest from an individual aggregating $600 or more for any calendar year on an SPVL must file an information return reporting the receipt of the interest.

Proposed regulations regarding the deduction for qualified passenger vehicle loan interest (QPVLI) and the information reporting requirements for the receipt of interest on a specified passenger vehicle loan (SPVL), Code Sec. 163(h)(4), as added by the One Big Beautiful Bill Act (P.L. 119-21), provides that for tax years beginning after December 31, 2024, and before January 1, 2029, personal interest does not include QPVLI. Code Sec. 6050AA provides that any person engaged in a trade or business who, in the course of that trade or business, receives interest from an individual aggregating $600 or more for any calendar year on an SPVL must file an information return reporting the receipt of the interest.

Qualified Personal Vehicle Loan Interest

QPVLI is deductible by an individual, decedent's estate, or non-grantor trust, including a with respect to a grantor trust or disregarded entity deemed owned by the individual, decedent's estate, or non-grantor trust. The deduction for QPVLI may be taken by taxpayers who itemize deductions and those who take the standard deduction. Lease financing would not be considered a purchase of an applicable passenger vehicle (APV) and, thus, would not be considered a SPVL. QPVLI would not include any amounts paid or accrued with respect to lease financing.

Indebtedness will qualify as an SPVL only to the extent it is incurred for the purchase of an APV and for any other items or amounts customarily financed in an APV purchase transaction and that directly relate to the purchased APV, such as vehicle service plans, extended warranties, sales, and vehicle-related fees. Indebtedness is an SPVL only if it was originally incurred by the taxpayer, with an exception provided for a change in obligor due to the obligor's death. Original use begins with the first person that takes delivery of a vehicle after the vehicle is sold, registered, or titled and does not begin with the dealer unless the dealer registers or titles the vehicle to itself.

Personal use is defined to mean use by an individual other than in any trade or business, except for use in the trade or business of performing services as an employee, or for the production of income. An APV is considered purchased for personal use if, at the time of the indebtedness is incurred, the taxpayer expects the APV will be used for personal use by the taxpayer that incurred the indebtedness, or by certain members of that taxpayer's family and household, for more than 50 percent of the time. Rules with respect to interest that is both QPVLI and interest otherwise deductible under Code Sec. 163(a) or other Code section are provided and intended to provide clarity and to prevent taxpayers from claiming duplicative interest deductions. The $10,000 limitation of Code Sec. 163(h)(4)(C)(i) applies per federal tax return. Therefore, the maximum deduction on a joint return is $10,000. If two taxpayers have a status of married filing separately, the $10,000 limitation would apply separately to each return.

Information Reporting Requirements

If the interest recipient receives from any individual at least $600 of interest on an SPVL for a calendar year, the interest recipient would need to file an information return with the IRS and furnish a statement to the payor or record on the SPVL. Definitions of terms used in the proposed rules are provided in Prop. Reg. §1.6050AA-1(b).

Assignees of the right to receive interest payments from the lender of record are permitted to rely on the information in the contract if it is sufficient to satisfy its information reporting obligations. The assignee may choose to make arrangements to obtain information regarding personal use from the obligor, lender of record, or by other means. The written statement provided to the payor of record must include the information that was reported to the IRS and identify the statement as important tax information that is being furnished to the IRS and state that penalties may apply for overstated interest deductions.

Effective Dates and Requests for Comments

The regulations are proposed to apply to tax years in which taxpayers may deduct QPVLI pursuant to Code Sec. 163(h)(4). Taxpayers may rely on the proposed regulations under Code Sec. 163 with respect to indebtedness incurred for the purchase of an APV after December 31, 2024, and on or before the regulations are published as final regulations, so long as the taxpayer follows the proposed regulations in their entirety and in a consistent manner. Likewise, interest recipients may rely on the proposed regulations with respect to indebtedness incurred for the purchase of an APV after December 31, 2024, and on or before the date the regulations are published as final regulations, so long as the taxpayer follows the proposed regulations in their entirety and in a consistent manner.

Written or electronic comments must be received by February 2, 2026. A public hearing is scheduled for February 24, 2026.

Proposed Regulations, NPRM REG-113515-25

IR 2025-129

The IRS has released interim guidance to apply the rules under Regs. §§1.168(k)-2 and 1.1502-68, with some modifications, to the the acquisition date requirement for property qualifying for 100 percent bonus depreciation under Code Sec. 168(k)(1), as amended by the One Big Beautiful Bill Act (OBBBA) (P.L. 119-21). In addition, taxpayers may apply modified rules under to the elections to claim 100-percent bonus depreciation on specified plants, the transitional election to apply the bonus rate in effect in 2025, prior to the enactment of OBBBA, and the addition of qualified sound recording productions to qualified property under Code Sec, 168(k)(2). Proposed regulations for Reg. §1.168(k)-2 and Reg. §1.1502-68 are forthcoming.

The IRS has released interim guidance to apply the rules under Regs. §§1.168(k)-2 and 1.1502-68, with some modifications, to the the acquisition date requirement for property qualifying for 100 percent bonus depreciation under Code Sec. 168(k)(1), as amended by the One Big Beautiful Bill Act (OBBBA) (P.L. 119-21). In addition, taxpayers may apply modified rules under to the elections to claim 100-percent bonus depreciation on specified plants, the transitional election to apply the bonus rate in effect in 2025, prior to the enactment of OBBBA, and the addition of qualified sound recording productions to qualified property under Code Sec, 168(k)(2). Proposed regulations for Reg. §1.168(k)-2 and Reg. §1.1502-68 are forthcoming.

Under OBBBA qualified property acquired and specified plants planted or grafted after January 19, 2025, qualify for 100 percent bonus depreciation. When determining whether such property meets the acquisition date requirements, taxpayers may generally apply the rules under Regs. §§1.168(k)-2 and 1.1502-68 by substituting “January 19, 2025” for “September 27, 2017” and “January 20, 2025” for “September 28, 2017” each place it appears. In addition taxpayers should substitute “100 percent” for “the applicable percentage” each place it appears, except for the examples provided in Reg. § 1.168(k)-2(g)(2)(iv). Specifically, these rules apply to the acquisition date (Reg. § 1.168(k)-2(b)(5) and Reg. §1.1502-68(a) through (d)) and the component election for components of larger self-constructed property (Reg. § 1.168(k)-2(c)).

With regards to the Code Sec. 168(k)(5) election to claim 100-percent bonus depreciation on specified plants, taxpayer may follow the rules set forth in Reg. § 1.168(k)-2(f)(2). Taxpayers making the transitional election to apply the lower bonus rate in effect in 2025, prior to the enactment of OBBBA may follow Reg. § 1.168(k)-2(f)(3) after substituting “January 19, 2025” for “September 27, 2017”, “January 20, 2025” for “September 28, 2017”, and “40 percent” (“60 percent” in the case of Longer production period property or certain noncommercial aircrafts) for “50 percent”, and applicable Form 4562, Depreciation and Amortization,” for “2017 Form 4562, “Depreciation and Amortization,” each place it appears .

For qualified sound recording productions acquired before January 20, 2025, in a tax year ending after July 4, 2025, taxpayers should apply the rules under Reg. § 1.168(k)-2 as though a qualified sound recording production (as defined in Code Sec. 181(f)) is included in the list of qualified property provided in Reg. § 1.168(k)-2(b)(2)(i). If electing out of bonus depreciation for a qualified sound recording production under Code Sec. 168(k)(7) a taxpayer should follow the rules under Reg. § 1.168(k)-2(f)(1) as if the definition of class of property is expanded to each separate production of a qualified sound recording production.

Taxpayers may rely on this guidance for property placed in service in tax years beginning before the date the forthcoming proposed regulations are published in the Federal Register.

Notice 2026-11

IR 2026-6

The IRS released the optional standard mileage rates for 2026. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:

• business,
• medical, and
• charitable purposes

Some members of the military may also use these rates to compute their moving expense deductions.

The IRS released the optional standard mileage rates for 2026. Most taxpayers may use these rates to compute deductible costs of operating vehicles for:

• business,
• medical, and
• charitable purposes

Some members of the military may also use these rates to compute their moving expense deductions.

2026 Standard Mileage Rates

The standard mileage rates for 2026 are:

• 72.5 cents per mile for business uses;
• 20.5 cents per mile for medical uses; and
• 14 cents per mile for charitable uses.

Taxpayers may use these rates, instead of their actual expenses, to calculate their deductions for business, medical or charitable use of their own vehicles.

FAVR Allowance for 2026

For purposes of the fixed and variable rate (FAVR) allowance, the maximum standard automobile cost for vehicles places in service after 2026 is:

• $61,700 for passenger automobiles, and
• $61,700 for trucks and vans.

Employers can use a FAVR allowance to reimburse employees who use their own vehicles for the employer’s business.

2026 Mileage Rate for Moving Expenses

The standard mileage rate for the moving expense deduction is 20.5 cents per mile. To claim this deduction, the taxpayer must be:

• a member of the Armed Forces of the United States,
• on active military duty, and
• moving under an military order and incident to a permanent change of station

The Tax Cuts and Jobs Act of 2017 suspended the moving expense deduction for all other taxpayers until 2026.

Unreimbursed Employee Travel Expenses

For most taxpayers, the Tax Cuts and Jobs Act suspended the miscellaneous itemized deduction for unreimbursed employee travel expenses. However, certain taxpayers may still claim an above-the-line deduction for these expenses. These taxpayers include:

• members of a reserve component of the U.S. Armed Forces,
• state or local government officials paid on a fee basis, and
• performing artists with relatively low incomes.

Notice 2025-5, is superseded.

Notice 2026-10

IR 2025-128

The IRS issued frequently asked questions (FAQs) addressing the limitation on the deduction for business interest expense under Code Sec. 163(j). The FAQs provide general information to taxpayers and tax professionals and reflect statutory changes made by the Tax Cuts and Jobs Act, the CARES Act, and the One, Big, Beautiful Bill.

The IRS issued frequently asked questions (FAQs) addressing the limitation on the deduction for business interest expense under Code Sec. 163(j). The FAQs provide general information to taxpayers and tax professionals and reflect statutory changes made by the Tax Cuts and Jobs Act, the CARES Act, and the One, Big, Beautiful Bill.

General Information

The FAQs explain the Code Sec. 163(j) limitation, identify taxpayers subject to the limitation, and describe the gross receipts test used to determine whether a taxpayer qualifies as an exempt small business.

Excepted Trades or Businesses

The FAQs address trades or businesses that are excepted from the Code Sec. 163(j) limitation, including electing real property trades or businesses, electing farming businesses, regulated utility trades or businesses, and services performed as an employee.

Determining the Section 163(j) Limitation Amount

The FAQs explain how to calculate the Code Sec. 163(j) limitation, including the definitions of business interest expense and business interest income, the computation of adjusted taxable income, and the treatment of disallowed business interest expense carryforwards.

CARES Act Changes

The FAQs describe temporary modifications to Code Sec. 163(j) made by the CARES Act, including increased adjusted taxable income percentages and special rules and elections applicable to partnerships and partners for taxable years beginning in 2019 and 2020.

One, Big, Beautiful Bill Changes

The FAQs outline amendments made by the One, Big, Beautiful Bill, including changes affecting the calculation of adjusted taxable income for tax years beginning after Dec. 31, 2024, and the application of Code Sec. 163(j) before interest capitalization provisions for tax years beginning after Dec. 31, 2025.

FS-2025-9

IR 2025-126

The IRS issued frequently asked questions (FAQs) addressing updates to the Premium Tax Credit. The FAQs clarified changes to repayment rules, the removal of outdated provisions and how the IRS will treat updated guidance.

The IRS issued frequently asked questions (FAQs) addressing updates to the Premium Tax Credit. The FAQs clarified changes to repayment rules, the removal of outdated provisions and how the IRS will treat updated guidance.

Removal of Repayment Limitations

For tax years beginning after December 31, 2025, limitations on the repayment of excess advance payments of the Premium Tax Credit no longer applied.

Previously Applicable Provisions

Premium Tax Credit rules that applied only to tax years 2020 and 2021 were no longer applicable and were removed from the FAQs.

Updated FAQs

The FAQs were updated throughout for minor style clarifications, topic updates and question renumbering.

Reliance on FAQs

The FAQs were issued to provide general information to taxpayers and tax professionals and were not published in the Internal Revenue Bulletin.

Legal Authority

If an FAQ was inconsistent with the law as applied to a taxpayer’s specific circumstances, the law controlled the taxpayer’s tax liability.

Penalty Relief

Taxpayers who reasonably and in good faith relied on the FAQs were not subject to penalties that included a reasonable cause standard for relief, to the extent reliance resulted in an underpayment of tax.

FS-2025-10

IR 2025-127

The IRS issued guidance providing penalty relief to individuals and corporations that make a valid Code Sec. 1062 election to defer taxes on gains from the sale of qualified farmland. Taxpayers who opt to pay their applicable net tax liability in four annual installments will not be penalized under sections 6654 or 6655 for underpaying estimated taxes in the year of the sale.

The IRS issued guidance providing penalty relief to individuals and corporations that make a valid Code Sec. 1062 election to defer taxes on gains from the sale of qualified farmland. Taxpayers who opt to pay their applicable net tax liability in four annual installments will not be penalized under sections 6654 or 6655 for underpaying estimated taxes in the year of the sale.

The relief permits these taxpayers to exclude 75 percent of the deferred tax from their estimated tax calculations for that year. However, 25 percent of the tax liability must still be paid by the return due date for the year of the sale. The IRS emphasized that this waiver applies automatically if the taxpayer qualifies and does not self-report the penalty.

Taxpayers who have already reported a penalty or receive an IRS notice can request abatement by filing Form 843, noting the relief under Notice 2026-3. This measure aligns with the policy objectives of the One, Big, Beautiful Bill Act of 2025, which introduced section 1062 to support farmland continuity by facilitating sales to qualified farmers. The IRS also plans to update relevant forms and instructions to reflect the changes, ensuring clarity for those seeking relief.

Notice 2026-3

The IRS has extended the transition period provided in Rev. Rul. 2025-4, I.R.B. 2025-6, for states administering paid family and medical leave (PFML) programs and employers participating in such programs with respect to the portion of medical leave benefits a state pays to an individual that is attributable to employer contributions, for an additional year.

The IRS has extended the transition period provided in Rev. Rul. 2025-4, I.R.B. 2025-6, for states administering paid family and medical leave (PFML) programs and employers participating in such programs with respect to the portion of medical leave benefits a state pays to an individual that is attributable to employer contributions, for an additional year.

The IRS found that states with PMFL statuses have requested that the transition period be extended for an additional year or that the effective date be amended because the required changes cannot occur within the current timeline. For this reason, calendar year 2026 will be regarded as an additional transition period for purposes of IRS enforcement and administration with respect to the following components:

• For medical leave benefits a state pays to an individual in calendar year 2026,with respect to the portion of the medical leave benefits attributable to employer contributions, (a) a state or an employer is not required to follow the income tax withholding and reporting requirements applicable to third-party sick pay, and (b)consequently, a state or employer would not be liable for any associated penalties under Code Sec. 6721 for failure to file a correct information return or under Code Sec. 6722 for failure to furnish a correct payee statement to the payee; and

• For medical leave benefits a state pays to an individual in calendar year 2026, with respect to the portion of the medical leave benefits attributable to employer contributions, (a) a state or an employer is not required to comply with § 32.1 and related Code sections (as well as similar requirements under § 3306) during thecalendar year; (b) a state or an employer is not required to withhold and pay associatedtaxes; and (c) consequently, a state or employer would not be liable for any associated penalties.

This notice is effective for medical leave benefits paid from states to individuals during calendar year 2026.

Notice 2026-6

Addressing health care will be the key legislative priority a 2026 starts, leaving little chance that Congress will take up any significant tax-related legislation in the coming election year, at least until health care is taken care of.

Addressing health care will be the key legislative priority a 2026 starts, leaving little chance that Congress will take up any significant tax-related legislation in the coming election year, at least until health care is taken care of.

Top legislative staff from the tax writing committees in Congress (House Ways and Means Committee and Senate Finance Committee) were all in basic agreement during a January 7, 2026, panel discussion at the 2026 D.C. Bar Tax Conference that health care would be tackled first.

“I will say that my judgement, and this is not the official party line, by that my judgement is that a deal on health care is going to have to unlock before there’s a meaningful tax vehicle,” Andrew Grossman, chief tax counsel for the House Ways And Means Committee Democratic staff, said, adding that it is difficult to see Democratic members working on tax extenders and other provisions when 15 million are about to lose their health insurance.

Sean Clerget, chief tax counsel for the Ways and Means GOP staff, added that “our view’s consistent with what Andrew [Grossman] said, adding that committee chairman Jason Smith (R-Mo.) “would be very open to having a tax vehicle whether or not there’s a health care deal, but obviously we need bipartisan cooperation to move something like that. And so, Andrew’s comments are sort of very important to the outlook on this.”

Even some of the smaller items that may have bipartisan support could be held up as the parties work to find common ground on health care legislation.

“It’s hard to see some of the smaller tax items that are hanging out there getting over the finish line without a deal on health, Sarah Schaefer, chief tax advisor to the Democratic staff of the Senate Finance Committee, said. “And I think our caucus will certainly hold out for that.”

Randy Herndon, deputy chief tax counsel for the Finance Committee Republican staff, added that he agreed with Clerget and said that Finance Committee Chairman Mike Crapo (R-Idaho) would be “open to a tax vehicle absent any health care deal, but understand, again, the bipartisan cooperation that would be required.”

No Planned OBBBA Part 2

Clerget said that currently there no major reconciliation bill on the horizon to follow up on the One Big Beautiful Bill Act, but “I’ve always thought that if there were to be a second reconciliation bill, it would need to be very narrow for a very specific purpose, rather than a large kind of open, multicommittee, big bill.”

Herndon added that Chairman Crapo’s “current focus is on pursuing potential bipartisan priorities in the Finance Committee jurisdiction,” noting that a lot of the GOP priorities were addressed in the OBBBA “and our members are very invested in seeing that through the implementation process.”

Of the things we can expect the committees to work on, Herndon identified areas ripe for legislative activity in the coming year, including crypto and tax administration bills and other focused issues surrounding affordability, but GOP members will more be paying attention to the implementation of OBBBA.

Schaefer said that Finance Committee Democrats will maintain a focus on the child tax credit as well as working to get reinstated clean energy credits that were allowed to expire.

Clerget said that of the things that could happen on this legislative calendar is on the taxation of digital assets, stating that “I think there’s a lot of interest in establishing clear tax rules in the digital asset space.… I think we have a good prospect of getting bipartisan cooperation on the tax side of digital assets.”

He also said there has been a lot of bipartisan cooperation on tax administration in 2025, suggesting that the parties could keep working on improving the taxpayer experience in 2026.

By Gregory Twachtman, Washington News Editor

The Fifth Circuit Court of Appeals held that a "limited partner" in Code Sec. 1402(a)(13) is a limited partner in a state-law limited partnership that has limited liability. The court rejected the "passive investor" rule followed by the IRS and the Tax Court in Soroban Capital Partners LP (Dec. 62,310).

The Fifth Circuit Court of Appeals held that a "limited partner" in Code Sec. 1402(a)(13) is a limited partner in a state-law limited partnership that has limited liability. The court rejected the "passive investor" rule followed by the IRS and the Tax Court in Soroban Capital Partners LP (Dec. 62,310).

Background

A limited liability limited partnership operated a business consulting firm, and was owned by several limited partners and one general partner. For the tax years at issue, the limited partnership allocated all of its ordinary business income to its limited partners. Based on the limited partnership tax exception in Code Sec. 1402(a)(13), the limited partnership excluded the limited partners’ distributive shares of partnership income or loss from its calculation of net earnings from self-employment during those years, and reported zero net earnings from self-employment.

The IRS adjusted the limited partnership's net earnings from self-employment, and determined that the distributive share exception in Code Sec. 1402(a)(13) did not apply because none of the limited partnership’s limited partners counted as "limited partners" for purposes of the statutory exception. The Tax Court upheld the adjustments, stating it was bound by Soroban.

Limited Partners and Self Employment Tax

Code Sec. 1402(a)(13) excludes from a partnership's calculation of net earnings from self-employment the distributive share of any item of income or loss of a limited partner, as such, other than guaranteed payments in Code Sec. 707(c) to that partner for services actually rendered to or on behalf of the partnership to the extent that those payments are established to be in the nature of remuneration for those services.

In Soroban, the Tax Court determined that Congress had enacted Code Sec. 1402(a)(13) to exclude earnings from a mere investment, and intended for the phrase “limited partners, as such” to refer to passive investors. Thus, the Tax Court there held that the limited partner exception of Code Sec. 1402(a)(13) did not apply to a partner who is limited in name only, and that determining whether a partner is a limited partner in name only required an inquiry into the limited partner's functions and roles.

Passive Investor Treatment

Here, the Fifth Circuit rejected the interpretation that "limited partner" in Code Sec. 1402(a)(13) refers only to passive investors in a limited partnership. Reviewing the text of the statute, the court determined that dictionaries at the time of Code Sec. 1402(a)(13)’s enactment defined "limited partner" as a partner in a limited partnership that has limited liability and is not bound by the obligations of the partnership. Also, longstanding interpretation by the Social Security Administration and the IRS had confirmed that a "limited partner" is a partner with limited liability in a limited partnership. IRS partnership tax return instructions had for decades defined "limited partner" as one whose potential personal liability for partnership debts was limited to the amount of money or other property that the partner contributed or was required to contribute to the partnership.

The Fifth Circuit determined that the interpretation of "limited partner" as a mere "passive investor" in a limited partnership is wrong. The court stated that the passive-investor interpretation makes little sense of the "guaranteed payments" clause in Code Sec. 1402(a)(13), and that the text of the statute contemplates that "limited partners" would provide actual services to the partnership and thus participate in partnership affairs. A strict passive-investor interpretation that defined "limited partner" in a way that prohibited him from providing any services to the partnership would make the "guaranteed payments" clause superfluous.

Further, the court stated that had Congress wished to only exclude passive investors from the tax, it could have easily written the exception to do so, but it did not do so in Code Sec. 1402(a)(13). Additionally, the passive investor interpretation would require the IRS to balance an infinite number of factors in performing its "functional analysis test," and would make it more complicated for limited partners to determine their tax liability.

The Fifth Circuit rejected the Tax Court's conclusion in Soroban that by adding the words "as such" in Code Sec. 1402(a)(13), Congress had made clear that the limited partner exception applies only to a limited partner who is functioning as a limited partner. Adding "as such" did not restrict or narrow the class of limited partners, and does not upset the ordinary meaning of "limited partner."

Vacating and remanding an unreported Tax Court opinion.

Sirius Solutions, L.L.L.P., CA-5

As the 2015 tax filing season comes to an end, now is a good time to begin thinking about next year's returns. While it may seem early to be preparing for 2016, taking some time now to review your recordkeeping will pay off when it comes time to file next year.

As the 2015 tax filing season comes to an end, now is a good time to begin thinking about next year's returns. While it may seem early to be preparing for 2016, taking some time now to review your recordkeeping will pay off when it comes time to file next year.

Taxpayers are required to keep accurate, permanent books and records so as to be able to determine the various types of income, gains, losses, costs, expenses and other amounts that affect their income tax liability for the year. The IRS generally does not require taxpayers to keep records in a particular way, and recordkeeping does not have to be complicated. However, there are some specific recordkeeping requirements that taxpayers should keep in mind throughout the year.

Business Expense Deductions

A business can choose any recordkeeping system suited to their business that clearly shows income and expenses. The type of business generally affects the type of records a business needs to keep for federal tax purposes. Purchases, sales, payroll, and other transactions that incur in a business generate supporting documents. Supporting documents include sales slips, paid bills, invoices, receipts, deposit slips, and canceled checks. Supporting documents for business expenses should show the amount paid and that the amount was for a business expense. Documents for expenses include canceled checks; cash register tapes; account statements; credit card sales slips; invoices; and petty cash slips for small cash payments.

The Cohan rule. A taxpayer generally has the burden of proving that he is entitled to deduct an amount as a business expense or for any other reason. However, a taxpayer whose records or other proof is not adequate to substantiate a claimed deduction may be allowed to deduct an estimated amount under the so-called Cohan rule. Under this rule, if a taxpayer has no records to provide the amount of a business expense deduction, but a court is satisfied that the taxpayer actually incurred some expenses, the court may make an allowance based on an estimate, if there is some rational basis for doing so.

However, there are special recordkeeping requirements for travel, transportation, entertainment, gifts and listed property, which includes passenger automobiles, entertainment, recreational and amusement property, computers and peripheral equipment, and any other property specified by regulation. The Cohan rule does not apply to those expenses. For those items, taxpayers must substantiate each element of an expenditure or use of property by adequate records or by sufficient evidence corroborating the taxpayer's own statement.

Individuals

• Record keeping is not just for businesses. The IRS recommends that individuals keep the following records:
• Copies of Tax Returns. Old tax returns are useful in preparing current returns and are necessary when filing an amended return.
• Adoption Credit and Adoption Exclusion. Taxpayers should maintain records to support any adoption credit or adoption assistance program exclusion.
• Employee Expenses. Travel, entertainment and gift expenses must be substantiated through appropriate proof. Receipts should be retained and a log may be kept for items for which there is no receipt. Similarly, written records should be maintained for business mileage driven, business purpose of the trip and car expenses for business use of a car.
• Business Use of Home. Records must show the part of the taxpayer's home used for business and that such use is exclusive. Records are also needed to show the depreciation and expenses for the business part of the home.
• Capital Gains and Losses. Records must be kept showing the cost of acquiring a capital asset, when the asset was acquired, how the asset was used, and, if sold, the date of sale, the selling price and the expenses of the sale.
• Basis of Property. Homeowners must keep records of the purchase price, any purchase expenses, the cost of home improvements and any basis adjustments, such as depreciation and deductible casualty losses.
• Basis of Property Received as a Gift. A donee must have a record of the donor's adjusted basis in the property and the property's fair market value when it is given as a gift. The donee must also have a record of any gift tax the donor paid.
• Service Performed for Charitable Organizations. The taxpayer should keep records of out-of-pocket expenses in performing work for charitable organizations to claim a deduction for such expenses.
• Pay Statements. Taxpayers with deductible expenses withheld from their paychecks should keep their pay statements for a record of the expenses.
• Divorce Decree. Taxpayers deducting alimony payments should keep canceled checks or financial account statements and a copy of the written separation agreement or the divorce, separate maintenance or support decree.

Don't forget receipts. In addition, the IRS recommends that the following receipts be kept:

• Proof of medical and dental expenses;
• Form W-2, Wage and Tax Statement, and canceled checks showing the amount of estimated tax payments;
• Statements, notes, canceled checks and, if applicable, Form 1098, Mortgage Interest Statement, showing interest paid on a mortgage;
• Canceled checks or receipts showing charitable contributions, and for contributions of $250 or more, an acknowledgment of the contribution from the charity or a pay stub or other acknowledgment from the employer if the contribution was made by deducting $250 or more from a single paycheck;
• Receipts, canceled checks and other documentary evidence that evidence miscellaneous itemized deductions; and
• Pay statements that show the amount of union dues paid.

Electronic Records/Electronic Storage Systems

Records maintained in an electronic storage system, if compliant with IRS specifications, constitute records as required by the Code. These rules apply to taxpayers that maintain books and records by using an electronic storage system that either images their hard-copy books and records or transfers their computerized books and records to an electronic storage media, such as an optical disk.

The electronic storage rules apply to all matters under the jurisdiction of the IRS including, but not limited to, income, excise, employment and estate and gift taxes, as well as employee plans and exempt organizations. A taxpayer's use of a third party, such as a service bureau or time-sharing service, to provide an electronic storage system for its books and records does not relieve the taxpayer of the responsibilities described in these rules. Unless otherwise provided under IRS rules and regulations, all the requirements that apply to hard-copy books and records apply as well to books and records that are stored electronically under these rules.

A business with a significant amount of receivables should evaluate whether some of them may be written off as business bad debts. A business taxpayer may deduct business bad debts if the receivable becomes partially or completely worthless during the tax year.

In general, most business taxpayers must use the specific charge-off method to account for bad debts. The deduction in any case is limited to the taxpayer's adjusted basis in the receivable.

The deduction allowed for bad debts is an ordinary deduction, which can serve to offset regular business income dollar for dollar. If the taxpayer holds a security, which is a capital asset, and the security becomes worthless during the tax year, the tax law only allows a deduction for a capital loss. However, notes receivable obtained in the ordinary course of business are not capital assets. Therefore, if such notes become partially or completely worthless during the tax year, the taxpayer may claim an ordinary deduction for bad debts.

For a taxpayer to sustain a bad debt deduction, the debt must be bona fide. The IRS looks carefully at a bad debt of a family member.

To be entitled to a business debt write off, the taxpayer must also make a reasonable attempt to collect the debt. However, in a nod to reality, the IRS does not request the taxpayer to turn the debt over to a collection agency or file a lawsuit in an attempt to collect the debt if doing so has little probability of success.

Deadlines for claiming a write off for any past business bad debt must be watched. Taxpayers have until the later of (1) seven years from the date they timely filed their tax return or (2) two years from the time they paid the tax, to claim a refund for a deduction for a wholly worthless debt not deducted on the original return.

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 May 2011.

May 4

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 27-29.

May 6

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 30 -May 3.

May 10

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

May 11

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 4-6.

May 13

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 7-10.

May 18

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 11-13.

May 20

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

May 20

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 14-17.

May 25

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 18-20.

May 27

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates May 21-24.

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

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

Note. Bonus depreciation may not be applicable because, among other reasons, you purchased the vehicle used. You may elect out of bonus depreciation or elect to increase the alternative minimum tax (AMT) credit limit under Code Sec. 53 instead of claiming bonus depreciation.

Bonus depreciation backdrop

The Small Business Jobs Act of 2010 extended 50 percent bonus depreciation through the end of 2010. The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 extended bonus depreciation for two years (through the end of 2012) and increased the bonus depreciation allowance rate from 50 percent to 100 percent for qualified property acquired after September 8, 2010 and before January 1, 2012, and placed in service before January 1, 2012.

Nevertheless, the additional first-year bonus depreciation amount applicable to vehicles is limited to $8,000, whether other assets in the same depreciation class are entitled to 50 percent or 100 percent bonus depreciation. Sport Utility Vehicles (SUVs) and pickup trucks with a gross vehicle weight rating (GVWR) in excess of 6,000 pounds continue to be exempt from the luxury vehicle depreciation caps (under Code Sec. 280F).

Passenger automobiles

The maximum depreciation limits under Code Sec. 280F for passenger automobiles first placed into service during the 2011 calendar year are:

- $11,060 for the first tax year ($3,060 if bonus depreciation is not taken);
- $4,900 for the second tax year;
- $2,950 for the third tax year; and
- $1,775 for each tax year thereafter.

Trucks and vans

The maximum depreciation limits under Code Sec. 280F for trucks and vans first placed into service during the 2011 calendar year are:

- $11,260 for the first tax year ($3,260 if bonus depreciation is not taken);
- $5,200 for the second tax year;
- $3,150 for the third tax year; and
- $1,875 for each tax year thereafter.

Leases

Lease payments for vehicles used for business or investment purposes are deductible in proportion to the vehicle's business use. Lessees, however, must include a certain amount in income during the year the vehicle is leased to partially offset the amount by which lease payments exceed the luxury auto limits.

In-plan Roth IRA rollovers are a relatively new creation, and as a result many individuals are not aware of the rules. The Small Business Jobs Act of 2010 made it possible for participants in 401(k) plans and 403(b) plans to roll over eligible distributions made after September 27, 2010 from such accounts, or other non-Roth accounts, into a designated Roth IRA in the same plan. Beginning in 2011, this option became available to 457(b) governmental plans as well. These "in-plan" rollovers and the rules for making them, which may be tricky, are discussed below.

In-plan Roth IRA rollovers are a relatively new creation, and as a result many individuals are not aware of the rules. The Small Business Jobs Act of 2010 made it possible for participants in 401(k) plans and 403(b) plans to roll over eligible distributions made after September 27, 2010 from such accounts, or other non-Roth accounts, into a designated Roth IRA in the same plan. Beginning in 2011, this option became available to 457(b) governmental plans as well. These "in-plan" rollovers and the rules for making them, which may be tricky, are discussed below.

Designated Roth account

401(k) plans and 403(b) plans that have designated Roth accounts may offer in-plan Roth rollovers for eligible rollover distributions. Beginning in 2011, the option became available to 457(b) governmental plans, allowing the plan to adopt an amendment to include designated Roth accounts to then offer in-plan Roth rollovers.

In order to make an in-plan Roth IRA rollover from a non-Roth account to the plan, the plan must have a designated Roth account option. Thus, if a 401(k) plan does not have a Roth 401(k) contribution program in place at the time the rollover contribution is made, the rollover generally cannot be made (however, a plan can be amended to allow new in-service distributions from the plan's non-Roth accounts conditioned on the participant rolling over the distribution in an in-plan Roth direct rollover). Not only may plan participants make an in-plan rollover, but a participant's surviving spouse, beneficiaries and alternate payees who are current or former spouses are also eligible.

Eligible amounts

To be eligible for an in-plan rollover, the amount to be rolled over must be eligible for distribution to you under the terms of the plan and must be otherwise eligible for rollover (i.e. an eligible rollover distribution). Generally, any vested amount that is held in 401(k) plans or 403(b) plans (or 457(b) plans) is eligible for an in-plan Roth rollover. Moreover, the distribution must satisfy the general distribution requirements that otherwise apply.

Direct rollover or 60-day rollover

An in-plan Roth rollover may be accomplished two ways: either through a direct rollover (wherein the plan's administrator directly transfers funds from the non-Roth account to the participant's designated Roth account) or through a 60-day rollover. With an in-plan Roth direct rollover, the plan trustee transfers an eligible rollover distribution from a participant's non-Roth account to the participant's designated Roth account in the same plan. With an-plan Roth 60-day rollover, the participant deposits an eligible rollover distribution within 60 days of receiving it from a non-Roth account into a designated Roth account in the same plan.

If you opt for the 60-day rollover option, the amounts rolled over are subject to 20 percent mandatory withholding.

Taxation

Taxpayers generally include the taxable amount (fair market value minus your basis in the distribution) of an in-plan Roth rollover in gross income for the tax year in which the rollover is received.

If you have questions about making an in-plan Roth IRA rollover, please contact our office.

Often, timing is everything or so the adage goes. From medicine to sports and cooking, timing can make all the difference in the outcome. What about with taxes? What are your chances of being audited? Does timing play a factor in raising or decreasing your risk of being audited by the IRS? For example, does the time when you file your income tax return affect the IRS's decision to audit you? Some individuals think filing early will decrease their risk of an audit, while others file at the very-last minute, believing this will reduce their chance of being audited. And some taxpayers don't think timing matters at all.

Often, timing is everything or so the adage goes. From medicine to sports and cooking, timing can make all the difference in the outcome. What about with taxes? What are your chances of being audited? Does timing play a factor in raising or decreasing your risk of being audited by the IRS? For example, does the time when you file your income tax return affect the IRS's decision to audit you? Some individuals think filing early will decrease their risk of an audit, while others file at the very-last minute, believing this will reduce their chance of being audited. And some taxpayers don't think timing matters at all.

What your return says is key

If it's not the time of filing, what really increases your audit potential? The information on your return, your income bracket and profession--not when you file--are the most significant factors that increase your chances of being audited. The higher your income the more attractive your return becomes to the IRS. And if you're self-employed and/or work in a profession that generates mostly cash income, you are also more likely to draw IRS attention.

Further, you may pique the IRS's interest and trigger an audit if:

• You claim a large amount of itemized deductions or an unusually large amount of deductions or losses in relation to your income;
• You have questionable business deductions;
• You are a higher-income taxpayer;
• You claim tax shelter investment losses;
• Information on your return doesn't match up with information on your 1099 or W-2 forms received from your employer or investment house;
• You have a history of being audited;
• You are a partner or shareholder of a corporation that is being audited;
• You are self-employed or you are a business or profession currently on the IRS's "hit list" for being targeted for audit, such as Schedule C (Form 1040) filers);
• You are primarily a cash-income earner (i.e. you work in a profession that is traditionally a cash-income business)
• You claim the earned income tax credit;
• You report rental property losses; or
• An informant has contacted the IRS asserting you haven't complied with the tax laws.

DIF score

Most audits are generated by a computer program that creates a DIF score (Discriminate Information Function) for your return. The DIF score is used by the IRS to select returns with the highest likelihood of generating additional taxes, interest and penalties for collection by the IRS. It is computed by comparing certain tax items such as income, expenses and deductions reported on your return with national DIF averages for taxpayers in similar tax brackets.

E-filed returns.  There is a perception that e-filed returns have a higher audit risk, but there is no proof to support it. All data on hand-written returns end up in a computer file at the IRS anyway; through a combination of a scanning and a hand input procedure that takes place soon after the return is received by the Service Center. Computer cross-matching of tax return data against information returns (W-2s, 1099s, etc.) takes place no matter when or how you file.

Early or late returns. Some individuals believe that since the pool of filed returns is small at the beginning of the filing season, they have a greater chance of being audited. There is no evidence that filing your tax return early increases your risk of being audited. In fact, if you expect a refund from the IRS you should file early so that you receive your refund sooner. Additionally, there is no evidence of an increased risk of audit if you file late on a valid extension. The statute of limitations on audits is generally three years, measured from the due date of the return (April 18 for individuals this year, but typically April 15) whether filed on that date or earlier, or from the date received by the IRS if filed after April 18.

Amended returns. Since all amended returns are visually inspected, there may be a higher risk of being examined. Therefore, weigh the risk carefully before filing an amended return. Amended returns are usually associated with the original return. The Service Center can decide to accept the claim or, if not, send the claim and the original return to the field for examination.

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 April 2011.

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 April 2011.

April 1

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 26-29.

April 6

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 30-April 1.

April 8

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 2-5.

April 11

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

April 18

Individuals. File a 2010 income tax return (Form 1040, 1040A, or 1040EZ) and pay any tax due.

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

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 9-12.

April 20

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 13-15.

April 22

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 16-19.

April 27

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 20-22.

April 29

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates April 23-26.

President Obama unveiled his fiscal year (FY) 2012 federal budget recommendations in February, proposing to increase taxes on higher-income individuals, repeal some business tax preferences, reform international taxation, and make a host of other changes to the nation's tax laws. The president's FY 2012 budget touches almost every taxpayer in what it proposes, and in some cases, what is left out.

Roadmap

Every federal budget proposal is just that: a proposal, or a list of recommendations from the White House to Congress. Ultimately, it is for Congress to decide whether to fund a particular government program and at what level. The same is true for tax cuts and tax increases. The final budget for FY 2012 will be a compromise. Nonetheless, President Obama's FY 2012 budget is a helpful tool to predict in what direction federal tax policy may move.

Individuals

In his FY 2012 budget, President Obama repeats his call for Congress to end the Bush-era tax cuts for higher-income individuals (which the president generally defines as single individuals with incomes over $200,000 and married couples with incomes over $250,000). The top individual income tax rates would increase to 36 percent and 39.6 percent, respectively, after 2012. For 2011 and 2012, the top two individual income tax rates are 33 percent and 35 percent, respectively. The president also proposes to limit the deductions of higher income individuals.

Additionally, the president wants Congress to extend the reduced tax rates on capital gains and dividends, but not for higher-income individuals. Single individuals with incomes above $200,000 and married couples with incomes above $250,000 would pay capital gains and dividend taxes at 20 percent rather than at 15 percent after 2012.

The president's FY 2012 budget, among other things, also proposes:

• An AMT patch (higher exemption amounts and other targeted relief) after 2011;
• A permanent American Opportunity Tax Credit (enhanced Hope education tax credit) after 2012;
• A permanent enhanced earned income credit;
• A new exclusion from income for certain higher education student loan forgiveness;
• One-time payments of $250 to Social Security beneficiaries, disabled veterans and others with a corresponding tax credit for retirees who do not receive Social Security; and
• A temporary extension of certain tax incentives, such as the state and local sales tax deduction and the higher education tuition deduction, for one year.

Some of the proposals in the president's FY 2012 budget impact how individuals interact with the IRS. Many taxpayers complain that when they call the IRS, the wait times to speak to an IRS representative are so long they hang up. The president proposes to increase the IRS's budget to hire more customer service representatives. The president also proposes to allow the IRS to accept debit and credit card payments directly, thereby enabling taxpayers to avoid third party processing fees.

Businesses

The tax incentives for businesses in the president's FY 2012 budget are generally targeted to specific industries. One popular but temporary business tax incentive would be made permanent. President Obama proposes to extend permanently the research tax credit. The president also proposes to permanently abolish capital gains tax on investments in certain small businesses.

Other business proposals include:

1. Employer tax credits for creating jobs in newly designated Growth Zones;
2. Additional tax breaks for investments in energy-efficient property;
3. More funds for grants in lieu of tax credits for specified energy property;
4. One-year extensions of some temporary business tax incentives, such as the Indian employment credit and environmental remediation expensing;
5. Modifying Form 1099 business information reporting; and
6. Extending and reforming Build America Bonds.

The president's FY 2012 budget does not include a cut in the U.S. corporate tax rate. Any reduction in the U.S. corporate tax rate is likely to come outside the budget process. The president has spoken often in recent weeks about reducing the U.S. corporate tax rate but he wants any reduction to be revenue neutral; that is, the cost of cutting the U.S. corporate tax rate must be paid for. President Obama has discussed closing some unspecific tax loopholes.

IRS operations

President Obama proposes a significant increase in funding for the IRS. Most of the money would go to hiring new revenue officers and boosting enforcement activities. The White House predicts that investing $13 billion in the IRS over the next 10 years will generate an additional $56 billion in additional tax revenue over the same time period.

Estate tax

Late last year, the White House and the GOP agreed on a maximum federal estate tax rate of 35 percent with a $5 million exclusion for 2010, 2011 and 2012. In his FY 2012 budget, the president proposes to return the federal estate tax to its 2009 levels after 2012 (a maximum tax rate of 45 percent and a $3.5 million exclusion). President Obama also proposes to limit the duration of the generation skipping transfer (GST) tax exemption and to make other estate-tax related changes.

Revenue raisers

The White House and Congress are both looking at ways to cut the federal budget deficit. Taxes are one way. The president's FY 2012 budget proposes a number of revenue raisers, especially in the area of international taxation and in fossil fuel production.

International taxation. The president's budget proposes to reduce tax incentives for U.S.-based multinational companies. One goal of this strategy is to encourage multinational companies to invest in job creation in the U.S. The president's FY 2012 budget calls for, among other things, to limit earnings stripping by expatriated entities, to limit income shifting through intangible property transfers, and to make more reforms to the foreign tax credit rules. If enacted, all of the proposed international taxation reforms would raise an estimated $129 billion in additional revenue over 10 years.

LIFO. President Obama proposes to repeal the last-in, first-out (LIFO) inventory accounting method for federal income tax purposes. Taxpayers that currently use the LIFO method would be required to write up their beginning LIFO inventory to its first-in, first-out (FIFO) value in the first tax year beginning after December 31, 2012. This proposal would raise an estimated $52.8 billion over 10 years.

Fossil fuel tax preferences. The Tax Code includes a number of tax incentives for oil, gas and coal producers. President Obama proposes to repeal nearly all of these tax breaks for oil, gas and coal companies. These proposals would raise an estimated $46.1 billion over 10 years.

Financial institutions. President Obama proposes to impose a financial crisis responsibility fee on large U.S. financial institutions. The fee, if enacted, would raise an estimated $30 billion in additional revenue over 10 years.

Carried interest. The president's FY 2012 budget proposes to tax carried interest as ordinary income. This proposal would raise an estimated $14.8 billion in additional revenue over 10 years.

Insurance company reforms. Insurance companies are subject to specific and very technical tax rules. President Obama proposes to overhaul the tax rules for insurance companies. If enacted, these reforms would raise an estimated $14 billion over 10 years.

These are just some of the revenue raisers in the president's FY 2012 budget. All of them will be extensively debated in Congress in the coming months. Our office will keep you posted on developments. If you have any questions about the president's FY 2012 budget proposals, please contact our office.

Under the Patient Protection and Affordable Care Act (PPACA) enacted in March 2010, small employers may be eligible to claim a tax credit of 35 percent of qualified health insurance premium costs paid by a taxable employer (25 percent for tax-exempt employers). The credit is designed to encourage small employers to offer health-insurance to their employees.

Under the Patient Protection and Affordable Care Act (PPACA) enacted in March 2010, small employers may be eligible to claim a tax credit of 35 percent of qualified health insurance premium costs paid by a taxable employer (25 percent for tax-exempt employers). The credit is designed to encourage small employers to offer health-insurance to their employees.

Employees and wages

An employer can claim the maximum 35 percent credit if it has no more than 10 full-time equivalent (FTE) employees receiving average annual wages of $25,000 or less. The credit is phased out as the number of FTEs increases to 25 and as average annual wages increase to $50,000.  An employer with 25 or more employees, or paying average annual wages of $50,000 or more per employee, will not receive a credit.

In counting FTEs, the employer should not include owners and family members.  Seasonal employees are not counted unless they work at least 120 days during the year. In determining average annual wages, employers must count all wages, bonuses, commissions or other compensation, including sick leave and vacation leave.

Applicable years

The credit took effect in 2010.  It did not expire at the end of 2010 but can be claimed from year to year.  The credit applies at the 35/25 percent levels for four years, through 2013. After 2013, the maximum credit increases to 50 percent for for-profit employers and 35 percent for tax-exempt employers, but only for two years. Thus, the credit can be claimed every year for the six years from 2010 and 2015.  The credit is recalculated every year based on the total health insurance premiums paid. Only non-elective employer premiums are counted; salary reduction contributions paid through a cafeteria plan or other arrangement are not counted.

Premiums

An employer must pay at least 50 percent of the premium cost of health insurance coverage, and must pay the same uniform percentage of costs for each employee who obtains health insurance through the employer. A transition rule for 2010 treats an employer as satisfying the uniformity rule as long as the employer pays at least 50 percent of the coverage costs of each employee, based on the cost of employee-only (single) coverage, even if the employer does not pay the same percentage of costs for each employee.

The premiums must be paid for qualified health insurance, such as a hospital or medical service plan or health maintenance organization. It includes coverage for dental, vision, long-term care, nursing home care, and coverage for a specified disease or illness.  Coverage does not accident insurance, disability income insurance, and workers' compensation.

Claiming the credit

The credit is determined on Form 8941, Credit for Small Employer Health Insurance Premiums. For-profit employers report the amount of the credit on Form 3800, General Business Credit, and attach the forms to their income tax return. As a general business credit, any unused credit (in excess of taxable income) can be carried back one year (except for a credit arising in 2010, the first year) or carried forward 20 years.  For-profit employers deduct the credit from the premiums paid for health insurance, when computing the deduction for health insurance premiums.

Tax-exempt employers report the credit on Form 990-T, Exempt Organization Business Income Tax Return, regardless of whether the organization is subject to tax on unrelated business income. The credit is refundable for tax-exempt employers, provided it does not exceed the employer’s income tax withholding and Medicare taxes. The credit is not refundable if the employer does not claim the credit on Form 990-T.

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 March 2011.

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 March 2011.

March 2

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 23-25.

March 4

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 26-March 1.

March 9

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 2-4.

March 10

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

March 11

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 5-8.

March 15

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

March 16

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 9-11.

March 18

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 12-15.

March 23

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 16-18.

March 25

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 19-22.

March 30

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates March 23-25.

Legislation enacted during the past few years, including the Small Business Jobs Act of 2010 and the more recently enacted Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act), contains a number of important tax law changes that affect 2011. Key changes for 2011 affect both individuals and businesses. Certain tax breaks you benefited from in 2010, or before, may have changed in amount, timing, or may no longer be available in 2011. However, new tax incentives may be valuable. This article highlights some of the significant tax changes for 2011.

New payroll tax cut for wage earners

New for calendar 2011 is a payroll tax cut for wage earners and self-employed individuals. The payroll tax cut, as provided by the 2010 Tax Relief Act, reduces the employee's share of Social Security taxes by two percent, from 6.2 percent to 4.2 percent, for all wages earned during the 2011 calendar year, up to the taxable wage base of $106,800. Future Social Security is not affected by the payroll tax cut.

Many workers can expect to see an average tax savings of more than $1,000 as a result of the new payroll tax cut. For example, a single individual who earns $40,000 annually and is paid weekly will see an extra $15 in her paycheck every week. A single individual who earns $60,000 annually and is paid bi-weekly will see an extra $46 in her paycheck.

Self-employed individuals also benefit from the payroll tax cut. Self-employed individuals will pay 10.4 percent on self-employment income up to the threshold.

Payroll companies and employers are responsible for implementing the payroll tax cut; employees do not need to adjust their withholding or take any other action. However, it is always a good decision regardless to review your withholding to ensure you are not withholding too much or too little.

No more Making Work Pay Credit. The payroll tax cut replaces the Making Work Pay Credit (MWPC), which expired at the end of 2010 and was not renewed for 2011. The MWPC provided a refundable tax credit of up to $400 for qualified single individuals and up to $800 for married taxpayers filing joint returns for 2009 and 2010.

Residential energy improvement credits

For individuals who may be making energy-efficient improvements to their homes in 2011 important changes have taken place for a popular tax credit. The 2010 Tax Relief Act extended the Code Sec. 25C nonbusiness energy efficient property credit for homeowners for one year, through December 31, 2011. However, more restrictive rules apply for 2011 than applied in 2010. Effective for property placed in service after December 31, 2010, an individual is entitled to a credit against tax in an amount equal to:

• 10 percent of the amount paid or incurred for qualified energy efficiency improvements (building envelope components) installed during the tax year, and
• The amount of residential energy property expenditures paid or incurred during the tax year.

The maximum credit allowable is $500 over the lifetime of the taxpayer. The $500 amount must be reduced by the aggregate amount of previously allowed credits the taxpayer received in 2006, 2007, 2009 and 2010. There are certain restrictions on the amounts claimed for certain items as well. The amount claimed for windows and skylights in a year can not exceed $200 less the total of the credits you claimed for these items in all earlier tax years ending after December 31, 2005. The credit also can not exceed:

 -- $50 for an advanced main circulating fan;
-- $150 for any qualified natural gas, propane, or hot water boiler; and
-- $300 for any item of energy efficient property

Energy-efficient credit for contractors

The 2010 Tax Relief Act retroactively extends the new energy efficient home credit for eligible contractors for two years, through December 31, 2011. Eligible contractors can claim a credit of $2,000 or $1,000 for each qualified new energy efficient home either constructed by the contractor or acquired by a person from the contractor for use as a residence during the tax year.

Annuity contracts

Beginning in 2011, taxpayers may partially annuitize non-retirement plan annuity payments they receive from an annuity contract. This partial annuitization applies to amounts you receive in tax years beginning after December 31, 2010 and applies to such an annuity, endowment or life insurance contract. If you receive an annuity for a period of 10 years or longer, or over one or more lives, under any portion of the annuity, endowment or life insurance contract, that portion is treated as a separate contract for purposes of annuity taxation.

FSAs, HSAs and Archers MSAs

The Patient Protection and Affordable Care Act enacted in 2010 places new limits on flexible spending arrangements (FSAs), health savings accounts (HSAs) and Archer medical savings accounts (Archer MSAs). After December 31, 2010, a distribution from an FSA, HSA or Archer MSA for a medicine or drug is a tax-free qualified medical expense only if the medicine or drug is a prescribed drug (determined without regard to whether such drug is available without a prescription) or is insulin. Additionally, for distributions made after 2010, the additional tax on distributions from an HSA that are not used for qualified medical expenses increases significantly, from 10 percent to 20 percent of the disbursed amount. The additional tax on distributions from an Archer MSA that are not used for qualified medical expenses increases from 15 percent to 20 percent of the disbursed amount.

Simple Cafeteria Plans for small employers

Beginning January 1, 2011, certain small employers can adopt "simple cafeteria plans," which provide certain nontaxable benefits to employees. Eligible employers generally include those with an average of 100 or fewer employees on business days during either of the two preceding tax years. Benefits of simple cafeteria plans can include certain medical coverage, group-term life insurance, flexible spending accounts (FSAs), and dependent care assistance.

New electronic filing rules for employers

Nearly all employers must use the IRS Electronic Federal Tax Payment System (EFTPS) for federal tax payments made in 2011. Beginning after December 31, 2010, employers must use electronic funds transfer (EFT) to make all federal tax deposits, including deposits of employment tax, excise tax, and corporate income tax. After December 31, 2010, Forms 8109 and 8109-B, Federal Tax Deposit Coupon, can no longer be used.

Employer payroll tax forgiveness expires

Qualified employers who hired unemployed workers after February 3, 2010 and prior to January 1, 2011 may have been eligible for payroll tax forgiveness. The Hiring Incentives to Restore Employment Act (HIRE Act) provided temporary forgiveness of the employer-share of Social Security tax for eligible new-hires. For each worker retained for at least a year, businesses may claim an additional general business tax credit, up to $1,000 per worker, when they file their 2011 income tax returns.

New broker basis reporting rules

Beginning in 2011, generally all brokers who are required to file information returns reporting gross proceeds of a "covered security" (such as corporate stock), must include in the return the customer's adjusted basis in the security. A broker must report the adjusted basis and type of gain (long term or short term gain or loss) for most stock acquired on or after January 1, 2011.

Reporting is generally undertaken on Form 1099-B, Proceeds from Broker and Barter Exchange Transactions. A "covered security" includes all stock acquired beginning in 2011, as mentioned above, except for stock in a mutual fund (regulated investment company or RIC) or stock acquired in connection with a dividend reinvestment plan (DRP). Reporting for these and other types of securities and options will need to be reported beginning after 2012 and 2013.

Real estate reporting requirements

Beginning in 2011, taxpayers receiving rental income from real estate who make payments of $600 or more during the tax year to a service provider (excluding incorporated entities) must provide an information return to the IRS, as well as the provider, reporting the payments. Typically, the information is to be reported on Form 1099-Misc. Certain exceptions, such as for hardship or active members of the uniformed services or employees of the intelligence community apply.

These are just some of the many important tax changes that expired at the end of 2010 or take effect this year. Please contact our office if you have any questions.

While Congress extended the reduced individual income tax rates with passage of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act) in late 2010, it also extended several educational tax benefits as well through 2012. As families plan their upcoming tax year, it is important to keep these benefits in mind.

American Opportunity Tax Credit

Individuals may continue to claim a credit against their federal tax liability based on tuition payments and certain related expenses. Previously referred to as the Hope Credit, the American Opportunity Tax Credit (AOTC) remains available for taxpayers for the 2011 and 2012 tax years. Qualifying families may claim an annual tax credit of up to $2,500 for undergraduate college expenses, up to $10,000 for a four-year program. According to a recently-issued report, Treasury predicts that 9.4 million families will be able to claim a total of $18.2 billion AOTC credits in 2011, an average of $1,900 per family.

Lifetime learning credit

Taxpayers can claim the lifetime learning credit for post-high school education, as well as courses to acquire or improve job skills. These institutions include colleges, universities, vocational schools, and any other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. The lifetime learning credit is limited to $2,000 per eligible student, based upon payment of tuition and other qualified expenses.  

The IRS released Tax Tip 2010-12 reminding taxpayers that they cannot claim both the lifetime learning credit and the AOTC for one child in a single tax year. However, if the family has multiple children in college, the family may apply the credits on a "per-student, per-year basis." This means that the family with two children in college, for example, could claim the AOTC for one child and the lifetime learning credit for the other.

Coverdell Education Savings Accounts

The 2010 Tax Relief Act also extended the increased maximum contribution amount to Coverdell education savings accounts. Taxpayers may contribute a maximum of $2,000 per year to these tax-preferred accounts. Earnings on these contributions grow tax-free, while amounts subsequently withdrawn are excludable from gross income to the extent used for qualified educational expenses.

Educational assistance programs

The 2010 Tax Relief Act also extended taxpayers' annual exclusion of up to $5,250 in employer-provided educational assistance from their gross income. The exclusion applies to both gross income for federal income tax purposes, as well as wages for employment tax purposes.

Federal Scholarships with Service requirements

The 2010 Tax Relief Act continues the gross income exclusion for scholarships with obligatory service requirements received by candidates at certain qualified educational organizations. The exclusion applies to scholarships granted by the National Health Service Corps Scholarship Program or the F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance Program.

Qualified Tuition and Expense Deduction

The 2010 Tax Relief Act also extends the above-the-line deduction for qualified tuition and related expenses through 2011. The deduction applies to tuition and fees paid for the enrollment of the taxpayer, the taxpayer's spouse, or any dependent for which the taxpayer is entitled to a dependency exemption. Taxpayers can not claim both one of the education tax credits and the tuition and expense deduction in a single year. These continue to be either/or tax breaks.

Student loan interest deduction

Finally, after the student graduates, they may still claim an educational tax benefit by repaying their educational loans. Within certain adjusted gross income limits, taxpayers may claim a deduction for interest paid on student loans. The 2010 Tax Relief Act extends favorable limits on this deduction. Through 2012, the law extended the increased modified adjusted gross income phase-out ranges, meaning more taxpayers can claim the deduction. The 2010 Tax Relief Act also extended the repeal of the 60-month limit on deductible payments.

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 2011.

February 2

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 26-28.

February 4

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates January 29-February 1.

February 9

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 2-4.

February 10

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

February 11

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 5-8.

February 15

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

February 16

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 9-11.

February 18

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 12-15.

February 24

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 16-18.

February 25

Employers. Semi-weekly depositors must deposit employment taxes for payroll dates February 19-22.

On December 17, 2010 President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (2010 Tax Relief Act). This sweeping new tax law includes a two-year extension of the Bush-era tax cuts, including extension of the current, lower individual tax rates and capital gains/dividend tax rates. The new tax law - the largest in over ten years - also includes a temporary estate tax compromise, as well as the extension of many popular individual and business tax incentives, an alternative minimum tax (AMT) "patch" for 2010 and 2011, 100 percent bonus depreciation for businesses, and more. The much-anticipated legislation provides tax relief to taxpayers across-the-board. Here is a review of the 2010 Tax Relief Act's major provisions:

Individuals

Income tax rates. Among the most valuable tax breaks for individuals in the new law is a two-year extension of individual income tax rate reductions. The new law retains the current 10, 15, 25, 28, 33, and 35 percent individual tax rates for two years, through December 31, 2012. If Congress had not passed this extension, the individual tax rates would have jumped significantly for all income levels.

The new law also extends the full repeal of the limitation on itemized deductions and the personal exemption phaseout for higher-income taxpayers, through December 31, 2012.

Capital gains/dividends. The new law extends reduced capital gains and dividend tax rates for two years, through December 31, 2012. For 2011 and 2012, individuals in the 10 and 15 percent rate brackets can continue to take advantage of a zero percent capital gains and dividend tax rate. Individuals in higher rate brackets will enjoy a maximum tax rate of 15 percent on capital gains and dividends, as opposed to a 20 percent rate on capital gains and ordinary income tax rates on dividends.

Marriage penalty relief. Married couples filing jointly will benefit from provisions designed to provide relief from the marriage penalty. For 2010, the standard deduction for a married couple filing a joint return is twice the single taxpayer's amount. The 2010 Tax Relief Act extends the increased standard deduction for married taxpayers for two years, through December 31, 2012. The 2010 Tax Relief Act extends the expanded 15 percent rate bracket for married couples filing a joint return for two years, through December 31, 2012.

Payroll tax cut. The new law provides a payroll tax cut for employees. Effective for calendar year 2011, the employee share of the OASDI portion of Social Security taxes is reduced from 6.2 percent to 4.2 percent, up to the taxable wage base of $106,800. Self-employed individuals will get an equivalent tax break, paying 10.4 percent on self-employment income up to the wage base (reduced from the normal 12.4 percent rate). The payroll tax cut replaces the Making Work Pay credit that has been in place for 2009 and 2010, but generally offers a much higher benefit. Unlike the Making Work Pay credit, the payroll tax cut does not exclude individuals based on their earnings. Thus the payroll tax cut can provide significantly higher benefits -- a maximum payroll tax reduction of $2,136 on wages, compared to a maximum $800 Making Work Pay credit for married couples filing jointly and $400 for unmarried individuals.

AMT patch. The new law provides an AMT "patch" for 2010 as well as 2011 at higher exemption amounts. The 2010 Tax Relief Act raises the exemption amounts for 2010 to $47,450 for individuals, $72,450 for married taxpayers filing joint returns, and $36,225 for married taxpayers filing separately. For 2011, the amounts are increased to $48,450 for individuals, $74,450 for married taxpayers filing jointly, and $37,225 for married taxpayers filing separately.

More incentives. Along with all these incentives, the new law extends many popular but temporary tax breaks. Extended for 2011 and 2012 are:

• $1,000 child tax credit;
• Enhanced earned income tax credit;
• Adoption credit with modifications;
• The enhanced dependent care credit; and
• Deduction for certain mortgage insurance premiums.

The new law also extends retroactively some other valuable tax incentives for individuals that expired at the end of 2009. These incentives are extended for 2010 and 2011 and include:

• State and local sales tax deduction;
• Teacher's classroom expense deduction;
• Charitable contributions of IRA proceeds; and
• Charitable contributions of appreciated property for conservation purposes.

Businesses

Bonus depreciation. Businesses can use bonus depreciation to immediately write off a percentage of the cost of depreciable property. The new law provides 100 percent bonus depreciation for qualified investments made after September 8, 2010 and before January 1, 2012. It also continues bonus depreciation, albeit at 50 percent, on property placed in service after December 31, 2011 and before January 1, 2013. There are special rules for certain longer-lived and transportation property. Additionally, certain taxpayers may claim refundable credits in lieu of bonus depreciation.

Code Sec. 179 expensing. Along with bonus depreciation, the new law also provides for enhanced Code Sec. 179 expensing for 2012. Under current law, the Code Sec. 179 dollar and investment limits are $500,000 and $2 million, respectively, for tax years beginning in 2010 and 2011. The new law provides for a $125,000 dollar limit (indexed for inflation) and a $500,000 investment limit (indexed for inflation) for tax years beginning in 2012 (but not after). Otherwise, those caps would have dropped to a $25,000/$200,000 level.

Research credit. Congress extended the research tax credit for two years, for 2010 and 2011.

More incentives. Other valuable business incentives in the new law include extensions of:

• 100 percent exclusion of gain from qualified small business stock;
• Transit benefits parity;
• Work Opportunity Tax Credit (with modifications);
• New Markets Tax Credit (with modifications);
• Differential wage credit;
• Brownfields remediation;
• Active financing exception/look-through treatment for CFCs;
• Tax incentives for empowerment zones; and
• Special rules for charitable deductions by corporations and other businesses.

Energy Tax Breaks

Businesses. The new law extends some energy tax breaks for businesses. One of the most valuable energy incentives is the Code Sec. 1603 cash grant in lieu of tax credits. This incentive encourages the development of alternative energy sources, such as wind energy. Other business energy incentives extended by the new law include excise tax and other credits for alternative fuels, percentage depletion for oil and gas from marginal wells, and other targeted incentives.

Individuals. The new law also extends some popular energy tax incentives for individuals. Individuals who made energy efficiency improvements to their homes in 2009 or 2010 can benefit from the Code Sec. 25C energy tax credit, which rewards individuals who install energy efficient furnaces, add insulation, or make other similar improvements to reduce energy usage. The new law extends the credit through 2011 but reduces some of its benefits.

Education

The Tax Code includes a number of incentives to encourage individuals to save for education expenses. Many incentives are temporary and expired at the end of 2009, or were set to expire at the end of 2010. The new law extends for two years, through December 31, 2012, the following popular education tax breaks:

• The American Opportunity Tax Credit (previously the Hope education credit);
• Student loan interest deduction;
• Exclusion for employer-provided educational assistance;
• Enhanced Coverdell education savings accounts; and
• Special rules for certain scholarships.

The higher education tuition deduction was extended through 2011.

Estate and gift taxes

Beginning in 2011, the estate tax had been scheduled to revert to its pre-2001 levels of a 55 percent tax rate and a $1 million exclusion. For 2010, estates were subject to no federal estate tax but heirs had to take inherited property under a modified carryover tax basis regime.

Estate tax. The new law revives the estate tax through 2012, but at a reduced maximum estate tax rate of 35 percent and a $5 million exclusion. The revived estate tax applies to estates of decedents dying in 2011 and 2012. However, for 2010, the new law gives estates the option to apply the estate tax at the 35 percent/$5 million level, with a stepped-up basis, or to elect no estate tax but with modified carryover basis. The new law also allows "portability" between spouses of the maximum exclusion (for a combined $10 million benefit) and extends some other taxpayer-friendly provisions originally enacted in 2001.

This far-reaching tax package affects almost every taxpayer. Please contact our office if you have any questions on how you can start maximizing your savings within this sweeping $800 billion tax law.

Businesses will benefit from a number of extended and enhanced tax breaks under the recently enacted Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (2010 Tax Relief Act). The 2010 Tax Relief Act boosts 50-percent bonus depreciation to 100 percent through 2011 and provides increased Code Sec. 179 expensing in 2012.

100 percent bonus depreciation

The 2010 Tax Relief Act benefits businesses by increasing 50-percent bonus depreciation to 100-percent for qualified investments made after September 8, 2010 and before January 1, 2012 (before January 1, 2013 for certain longer-lived and transportation property). Thus, businesses that bought qualifying property after September 8, 2010 but before December 17, 2010 (the date of enactment of the 2010 Tax Relief Act) in anticipation of using 50-percent bonus depreciation received a welcome surprise as they will benefit from 100-percent bonus depreciation.

This provision is especially beneficial for businesses because bonus depreciation, unlike Code Sec. 179 expensing, is not limited to smaller companies, or capped at a certain dollar level. However, only new property qualifies for the 100-percent bonus depreciation (unlike Code Sec. 179 expensing, which can be claimed for both new and used property).

Example. In January 2011, Big Co., a calendar year business, buys $1 million of qualifying property eligible for the 100-percent bonus depreciation deduction. Under the 2010 Tax Relief Act's enhanced 100-percent bonus depreciation provision, Big Co. will be able to claim a $1 million depreciation deduction for the property on its 2011 tax return.

Post-2011 depreciation

Although enhanced 100-percent bonus depreciation is not extended into 2012, the new law does provide 50-percent bonus depreciation for qualified property placed in service after December 31, 2011 and before January 1, 2013.

Option to take refundable credits in lieu of bonus depreciation

The American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) provided that a corporation otherwise eligible for additional first-year depreciation may elect to claim additional research or minimum tax credits in lieu of claiming depreciation for qualified property placed in service after March 31, 2008 and before December 31, 2008. The 2010 Tax Relief Act generally extends similar treatment for two years, through December 31, 2012.

Code Section 179 expensing

Over the years, Congress has repeatedly increased dollar and investment limits under Code Sec. 179 to encourage spending by businesses. For tax years beginning in 2010 and 2011, the 2010 Small Business Jobs Act increased the Code Sec. 179 dollar and investment limits to $500,000 and $2 million, respectively. For tax years beginning in 2012, the new law provides for a $125,000 dollar limit and a $500,000 investment limit (both indexed for inflation). Without this provision, the dollar and investment limits would have reverted to $25,000 and $200,000 respectively for tax years beginning after 2011. Amounts that are not eligible for expensing due to excess investments can not be carried forward and expensed in a later year; they may only be recovered through depreciation.

Off-the-shelf computer software. The 2010 Tax Relief Act also provides that off-the-shelf computer software qualifies as eligible property for Code Sec. 179 expensing. The software must be "placed in service" (used) in a tax year beginning before 2013.

If you have any questions about these two business incentives under the 2010 Tax Relief Act, please call our office.

A business can deduct ordinary and necessary expenses paid or incurred in carrying on any trade or business. The expense must be reasonable and must be helpful to the business.

Gifts to a business client, customer or contact can be deductible business expenses. However, the maximum deduction for gifts to any individual is $25 per year (Code Sec. 274(b)). A gift is any item that is excluded from income under Code Sec. 102. Gifts that cost $4.00 or less, as well as promotional items, are not subject to the $25 limitation.

Gifts by individuals to co-workers are normally considered nondeductible personal expenses. However, employee achievement awards ($400 limit) and qualified plan awards are not subject to the $25 limitation.

Substantiation

Taxpayers must be able to substantiate certain business expenses by adequate records or sufficient evidence to take them as a deduction. Substantiation is required for business gifts, as well as traveling, lodging and entertainment expenses, because they are considered more susceptible to abuse (Tax Code Sec. 274(d)).

For business gifts, IRS regulations require that taxpayers substantiate the following elements of the gift:

- Amount (the cost to the taxpayer);
- Time (the date of the gift);
- Description of the gift;
- Business purpose - the business reason for the gift, or the nature of the business benefit derived or expected to be derived as a result of the gift; and
- Business relationship - occupation or other information relating to the recipient, including name, title and other designation, sufficient to establish the business relationship to the taxpayer.

The IRS provides substantiation rules in Treasury Reg. 1.274-5T(c). The taxpayer must maintain and produce, on request, "adequate records" or "sufficient evidence" that corroborate the taxpayer's own statement. Written evidence has "considerably more probative value" than oral evidence alone. While a contemporaneous log is not required, written evidence is more effective the closer in time it relates to the expense. Support by sufficient documentary evidence is highly credible.

Adequate records

Adequate records include an account book, diary, log, statement of expenses or similar records, as well as documentary evidence, which in combination establish each element of the expense. However, it is not necessary to record information that duplicates information on a receipt. The record should be prepared at or near the time of the expenditure, when the taxpayer has full present knowledge of each element. A statement, such as a weekly log, submitted by an employee to his employer in the regular course of good business practice is considered an adequate record.

An adequate record of business purpose generally requires a written statement of business purpose. However, the degree of substantiation will vary depending on the facts and circumstances.

Sufficient evidence

A taxpayer that does not have adequate records may establish an element by other sufficient evidence, such as the taxpayer's written or oral statement with specific, detailed information, and other corroborative evidence. A description of a gift shall be direct evidence, such as a detailed statement by the recipient or documentary evidence otherwise required as an adequate record.

If the taxpayer loses records through circumstances beyond the taxpayer's control, the taxpayer may substantiate the deduction by reasonably reconstructing his expenditures.

Starting in 2010, the just-passed Small Business Jobs Act of 2010 allows participants in 401(k), 403(b), and 457 governmental plans to roll over their pre-tax account balances in those plans to a designated Roth account set up by their employers within those plans. By converting account balances to a Roth designated account, distributions upon eventual retirement will be completely tax free both as to the amount rolled over and all subsequent earnings. Rollovers made in 2010 only also have the added advantage of deferring tax on the rollover for two years, into 2011 and 2012.  As a result, the sooner someone with a 401(k) or similar account can decide whether or not this rollover opportunity is right for him or her, the greater the tax savings that can be achieved.

Limited rollover opportunity

The Small Business Jobs Act of 2010 authorizes 401(k), 403(b) and 457 governmental plans to allow participants to roll over pre-tax account balances into a designed Roth account set up within the plan provided the plan also makes certain amendments to its governing rules to allow such rollovers.  Unfortunately, the rollover is taxable, except for any after-tax contributions.  Often evaluating this tax aspect comes down to a question of whether paying tax on what is a smaller amount now will save more overall dollars for your retirement years than paying the tax at retirement on a balance that has grown over the years. Many individuals will find that paying the rollover tax now does make sense.  This is especially the case if the cash used to pay the tax is drawn from other savings rather than from a withdrawal from the plan balance itself.  In this regard, special treatment for 2010 rollovers can help delay coming up with the cash for several years.  Participants who elect to make the rollover in 2010 will be taxed on the income over a two-year tax period, beginning in 2011, unless an election is made to recognize all of the income in 2010. This election – involving the ability to spread the income from the 2010 rollover in ratably 2011 and 2012 – echoes existing rules for converting a traditional IRA to a Roth IRA in 2010.

If a 401(k), 403(b), or 457(b) governmental plan has a qualified designated Roth contribution program, a distribution to an employee (or surviving spouse) from a non-Roth account to a Roth account is allowed to be rolled over into a designated Roth account under the participant’s plan. The distribution that the individual wants to roll over must be otherwise allowed under the plan. For example, amounts under a 401(k) plan that are subject to distribution restrictions cannot be rolled over to a designated Roth account.

Taking advantage of the special rule for 2010

First, the plan must be amended by the plan sponsor to allow for such rollovers as provided in the Small Business Jobs and Credit Act of 2010. It is intended that the IRS will provide employers with a remedial amendment period to allow the employers to offer this option for distributions during 2010 and then have adequate time to amend their plan.

Most importantly, participants must take action before year-end if they want to take advantage of either the two-year deferral into 2011 or 2012 or lower tax rates in 2010 if Congress does not extend the 2001 individual marginal income tax rate reductions which will disappear after December 31, 2010.

Businesses of all sizes are preparing for a possible avalanche of information reporting after 2011.

To help pay for health care reform, lawmakers tacked on expanded information reporting to the Patient Protection and Affordable Care Act (PPACA). The health care reform law generally requires all businesses, charities and state and local governments to file an information return for all payments aggregating $600 or more in a calendar year to a single provider of goods or services. The PPACA also repeals the longstanding reporting exception for payments to a corporation. The magnitude of the reporting requirement has opponents working feverishly to persuade Congress to either repeal it or scale it back.

Pre-PPACA law

Pre-PPACA law generally requires businesses to file an information return with the IRS reporting payments to non-corporate service providers that exceed $600 in a given year. Payments to providers of goods are excluded from reporting. Payments to a corporation for goods or services are excluded from reporting with some limited exceptions.

Sea change ahead

Effective for purchases made after December 31, 2011 the PPACA requires all businesses purchasing  $600 or more in goods or services from another entity (including corporations but not tax-exempt corporations), to provide the vendor and the IRS with an information return. Presumably, Form 1099-MISC will be used for purposes of the new reporting rule, or the IRS will develop a new form. We will keep you posted on developments.

Example. In February 2012, your business buys computers, printers, and fax machines from an office supply company, doing business as a corporation, for $4,000. Your business also spends $1,000 at a local caterer, doing business as a partnership, for office breakfasts and lunches throughout the year. Additionally, the company spends $600 for business travel on Amtrak. Your business must provide each of these vendors with a Form 1099 for 2012, as well as the IRS. 

Day-to-day transactions

Here are some more examples of purchases after 2011 that appear to fall under the PPACA’s reporting requirements:

-- You make small, incremental purchases from the same vendor; for example, your business purchases more than $600 of office supplies, such as staples, toner, pens, paper, and calendars from the same vendor.
-- You pay more than $600 throughout the year in mail and shipping costs to the same vendor; however each individual charge costs no more than $10 or $12.
-- You purchase floral arrangements for the office throughout the year, although each purchase may be no more than $40 to $70, your cumulative purchases are more than $600;
-- You purchase an $800 computer for your new employee;
-- You hold a summer picnic for your employees and purchase more than $600 in food from a local grocery store;
-- Every Friday you buy breakfast pastries from the local bakery for your employees, and even though each purchase is no more than $40, you spend more than $600 in the year.

Backup withholding

The PPACA requires sellers to provide, and purchasers to collect, Taxpayer Identification Numbers (TINs). If a seller fails to furnish a correct TIN, you must impose backup withholding at the rate of 28 percent of the purchase price.

Moreover, if your business fails to issue an accurately completed Form 1099 to a vendor, the IRS can assess a penalty.

Preparing now

There are some proactive steps your business can take now to prepare for the new reporting requirement and its heavy administrative and paperwork burden. The way you collect and manage vendor information will be more important than ever. Basic information you will need to track includes every vendor’s name and TIN, the amounts spent at each vendor and the total annual amount spent at each vendor.

You should also begin requesting that each of your vendors, particularly your regular vendors, complete IRS Form W-9 for your records. Form W-9 will provide you with the vendor’s legal name, address, and TIN.

Pending legislation

Opponents of the expanded information requirement are hoping that Congress will repeal it before 2012. Outright repeal is a long-shot. As written now, the PPACA reporting requirement is estimated to raise $17 billion over 10 years. Congress will need to find another source of revenue if it repeals the reporting requirement. More likely, Congress will modify the requirement.

Senate Democrats have introduced legislation to raise the reporting threshold from $600 to $5,000 and exclude some routine payments, such as office supplies, from reporting. All purchases made with a credit card would also be exempt from the reporting requirement. Additionally, small businesses employing not more than 25 employees would be completely exempt from the reporting requirement.

Many small employers want to offer their employees the opportunity to save for retirement but are unsure of how to go about setting up a retirement plan. In this article, we’ll explore three options that are widely used by small businesses: payroll deduction IRAs, SEP plans, and SIMPLE IRAs.

Many small employers want to offer their employees the opportunity to save for retirement but are unsure of how to go about setting up a retirement plan. In this article, we’ll explore three options that are widely used by small businesses: payroll deduction IRAs, SEP plans, and SIMPLE IRAs.

Payroll deduction IRAs

Many small employers find a payroll deduction IRA very attractive because it allows them to offer their employees a retirement savings vehicle at little cost. A business of any size, even self-employed individuals, can establish a payroll deduction IRA.Under a payroll deduction IRA, only your employees make contributions to an IRA.Your responsibility as an employer is simply to transmit the employee’s authorized deduction to the financial institution that maintains the IRA. 

The IRA is set up with a financial institution, such as a bank, mutual fund or insurance company. You can limit the number of IRA providers to as few as one. The employee establishes a traditional IRA or a Roth IRA (based on the employee’s eligibility and personal choice) with the financial institution and authorizes the payroll deductions.As the employer, you withhold the payroll deduction amounts authorized by your employees and send the funds to the financial institution.

An employee’s decision to participate in a payroll deduction IRA is entirely voluntarily. If an employee decides to participate, he or she can only contribute up to a certain amount to the payroll deduction IRA every year. For 2010, the contribution limit is $5,000. An employee age 50 or older may make an additional “catch-up” contribution of $1,000 for a yearly total of $6,000. Every employee who participates is 100 percent vested in the contributions to their payroll deduction IRA.

Let’s look at an example of a payroll deduction IRA:

Aidan’s employer offers its employees the opportunity to have deductions taken from their paychecks to contribute to IRAs that the employees have set up for themselves. Aidan signs up for the program and has $100 from his $1,000 bi-weekly paycheck deposited into his IRA for a yearly total of $2,600. At the end of the year, Aidan’s employer would report the full $26,000 he earned on his Form W-2 and Aidan would add the $2,600 to any other IRA contributions he made during the year for Form 1040 deduction purposes.

The costs of a payroll deduction IRA are low. Moreover, payroll deduction IRAs are not subject to the often complex filing, documentation and administration requirements that are imposed on other employer-sponsored retirement arrangements, such as 401(k) plans.

SEP plans

“SEP” stands for “Simplified Employee Pension” plan. While there are filing, administration and documentation requirements for SEP plans, the goal of an SEP plan is to keep these as simple as possible. The IRS has created, for example, model SEP language for plan documents.

An SEP plan is similar to a payroll deduction IRA. Under an SEP plan, employers make contributions to traditional IRAs set up for employees (including self–employed individuals). An SEP-IRA is funded solely by employer contributions whereas a payroll deduction IRA is funded solely by employee contributions.

As the employer, you must select the financial institution for your SEP. This decision must be made carefully because you and the financial institution will very work closely to administer the plan. After you send the SEP contributions to the financial institution, the financial institution will manage the funds.  Depending on the financial institution, SEP contributions can be invested in individual stocks, mutual funds, and other similar types of investments.

Federal law requires you and the trustee to keep employees informed about the administration and health of the SEP. Employees must be provided with plan documents, an annual statement that reports the fair market value of each employee’s account and a copy of an annual statement that is filed by the financial institution with the IRS. Like a payroll deduction IRA, each employee is 100 percent vested in his or her SEP-IRA.

Generally, the annual contributions an employer makes to an employee’s SEP-IRA cannot exceed the lesser of:

-- 25 percent of compensation, or

-- $49,000 for 2010.

Generally, contributions are not required to be made every year to an SEP. In years that contributions are made to an SEP, they must be made to the SEP-IRAs of all eligible employees.

Contributions to an SEP-IRA must be made in cash; property cannot be contributed to an SEP-IRA. Special rules apply if you, as the employer, also contribute to a 401(k) or similar plan on the employee’s behalf.

All eligible employees must be allowed to participate. An eligible employee is any employee who is at least age 21 and has worked for you in at least three of the immediate past five years.

To encourage employers to establish SEPs, the government offers a tax credit. You may be eligible for a tax credit of up to $500 for each of the first three years for the cost of starting the SEP.

SIMPLE IRAs

A “SIMPLE IRA” is a Savings Incentive Match Plan for Employees IRA. Like an SEP plan, a SIMPLE IRA is intended to be easily created and administrated.

A SIMPLE IRA is funded both by employer and employee contributions. As the employer, you can choose either to (1) match the contributions of employees who decide to participate or (2) contribute a fixed percentage of all eligible employees’ pay. Under option (2), which is known as the nonelective contribution formula, even if an eligible employee does not contribute to his or her SIMPLE IRA, you must make a contribution to the employee’s SIMPLE IRA equal to a fixed percent of the employee’s salary. Each employee is 100 percent vested in his or her SIMPLE IRA.

While similar to a payroll deduction IRA, a SIMPLE IRA has additional requirements. One important requirement is the number of employees. Generally, your business must have 100 or fewer employees to be eligible for a SIMPLE IRA.

Let’s look at an example of a SIMPLE IRA. In this example, the employer matches the employee contributions of employees who decide to participate.

Allison’s employer has established a SIMPLE IRA plan for its employees. The employer will match its employees’ contributions dollar-for-dollar up to three percent of each employee’s salary. If an employee does not contribute to his or her SIMPLE IRA, then that employee does not receive a matching employer contribution. Allison decides to contribute five percent ($2,500) of her annual salary of $50,000 to a SIMPLE IRA. The employer’s matching is $1,500 (three percent of $50,000). Therefore, the total contribution to Allison’s SIMPLE IRA that year is $4,000.

There are contribution limits for SIMPLE IRAs. For employees, the annual contribution limit is $11,500 in 2010. Employees age 50 and older may make additional catch-up contributions of $2,500 in 2010.

The SIMPLE IRA contribution for the employer is dependent upon which contribution formula you select. If you decide to make matching contributions, only eligible employees who have elected to make contributions will receive an employer contribution.If you decide to make a nonelective contribution, each eligible employee must receive a contribution regardless of whether the employee makes contributions.

As with an SEP plan, a SIMPLE IRA creates a relationship between you and the financial institution that manages the funds. SIMPLE IRA plan contributions can be invested in individual stocks, mutual funds and similar types of investments. Each participating employee must receive an annual statement indicating the amount contributed to his or her SIMPLE IRA for the year.

As with SEP plans, you may be eligible for a tax credit to help you offset start-up costs. The tax credit can reach up to $500 per year for each of the first three years for the cost of starting a SIMPLE IRA plan.

We’ve covered a lot of material about retirement plans for small businesses. There are more detailed requirements, especially for SEP plans and SIMPLE IRAs, which we can discuss in depth. Please contact our office to set up an appointment to explore these and other retirement arrangements for small businesses.

It is no secret to students, working individuals going back to school, and their families that the cost of education is becoming continuously more expensive year after year. The Tax Code provides a variety of significant tax breaks to help pay for the rising costs of education, from elementary and secondary school to college and graduate school. Individuals may be surprised to learn the many different ways the tax laws can help make education more affordable these days. In addition to scholarships, loans and work-study grants, or simply by themselves, these incentives can provide valuable cost savings.

It is no secret to students, working individuals going back to school, and their families that the cost of education is becoming continuously more expensive year after year. The Tax Code provides a variety of significant tax breaks to help pay for the rising costs of education, from elementary and secondary school to college and graduate school. Individuals may be surprised to learn the many different ways the tax laws can help make education more affordable these days. In addition to scholarships, loans and work-study grants, or simply by themselves, these incentives can provide valuable cost savings.

 Lifetime Learning Credit

 The Lifetime Learning credit can be claimed for qualified tuition and fees paid by an individual for his or her (or a spouse’s or dependent’s) enrollment at any college, university, vocational school, or postgraduate school. The credit is equal to 20 percent of up to $10,000 of the qualified tuition and related expenses paid by a taxpayer during the tax year. Thus, the maximum credit amount per taxpayer return is $2,000.

 The Lifetime Learning credit can be claimed for all years of postsecondary school (as well as for courses to acquire or improve job skills). However, the credit phases out as your modified AGI rises, and you can not claim the credit if you are married filing separately. You cannot claim a credit if your modified AGI is $60,000 or more ($120,000 or more if you file a joint return).

 American Opportunity Tax Credit

 The American Opportunity Tax Credit (AOTC), which was previously the Hope scholarship credit but temporarily enhanced and renamed the AOTC for 2009 and 2010, can also be claimed for qualified tuition and fees paid by an individual for his or her (or a spouse’s or dependent’s) enrollment or attendance at any college, university, vocational school or postgraduate school.

 The AOTC can be used for all four years of post-secondary school. Further, the credit can be taken for more expenses, such as text books and course materials. And, although the credit phases out as adjusted gross income (AGI) rises, the income phase out range is increased through 2010 as well. Additionally, 40 percent of the credit is refundable.

 For 2010, the AOTC is available up to a maximum of $2,500 per eligible student, per year (100 percent of the first $2,000 eligible expenses plus 25 percent of the next $2,000 eligible expenses). The credit phases out at higher income levels, making the credit available to more families as well. The amount of the credit begins to phase out when an individual’s AGI falls between $80,000 to $90,000 AGI. For married joint filers the credit phases out when AGI falls between $160,000 and $180,000.

 AOTC vs. Lifetime Learning credit

 The AOTC and Lifetime Learning credits cannot both be taken for the same student in the same year. If you pay the qualified education expenses of more than one student in the same year, however, you can choose to take the credits on a per-student basis for that year (for example, you may claim the AOTC for your daughter and the lifetime learning credit for your son, etc). You should calculate the effect of the AOTC, Lifetime Learning Credit (and, if retroactively reinstated for the 2010 year, the higher education expense deduction) on your tax return to see which incentive achieves the greatest tax savings. Remember, also, in “doing the math” that the tax benefits are based on calendar tax years and not school academic years.

 Coverdell Education Savings accounts

 Individuals can contribute up to $2,000 a year to a Coverdell Education Savings account, which is established to help pay for the costs of education of an account beneficiary. A beneficiary is someone who is under age 18 or with special needs.

 Although contributions to a Coverdell account are not deductible, earnings grow tax-free, and distributions are also tax free if used for qualified education expenses, including tuition and fees, required books, supplies and equipment, as well as qualified expenses for room and board. The account can help pay for the costs of attending an elementary or secondary school, whether public, private or religious, as well as a college or university.

 As with the education credits, there are contribution limits based on the contributor’s modified AGI.  

 IRA withdrawals for education expenses

 Generally, if you take a distribution from your IRA before you reach age 59½ you must pay a 10 percent additional tax on the early distribution, as well as income tax on the amount distributed. This applies to any IRA you own, whether it is a traditional IRA, a Roth IRA or a SIMPLE IRA. However, you can take an IRA distribution before age 59½ and avoid the 10 percent tax (but not the inclusion of the distributed amount in income for income tax purposes), if the distribution is used to pay the qualified education expenses for:

 -- Yourself;

-- Your spouse; or

-- Your or your spouse's child, grandchild or foster child.

 The amount of the withdrawal is generally limited to $10,000. Qualified education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at any college, university, vocational school or other post-secondary educational institution. In addition, if the student is at least a part-time student, room and board are generally qualified education expenses, subject to certain limitation.

 Section 529 college savings plans

 Qualified tuition programs, more commonly referred to as 529 plans, allow you to either prepay education expenses or contribute to an account set up for paying a student’s qualified education expenses at eligible educational institutions. A 529 plan allows you to save money, tax-free, to pay for qualified education expenses for college. Although contributions are not deductible for federal tax purposes, many states allow residents to deduct contributions on their state tax return. Moreover, withdrawals from a 529 plan are tax-free unless the amount distributed is greater than the account beneficiary’s adjusted qualified education expenses. Qualified education expenses include amounts paid for tuition, fees, books, supplies and equipment, as well as reasonable costs of room and board for individuals are at least part-time students.

 Computer and technology expenses. Through 2010, parents and students can take tax-free withdrawals from their 529 plans to buy computers and computer-related equipment for college. The 2009 Recovery Act added computers, computer equipment, technology, internet access, and “related services” to the list of qualified higher education expenses that can be paid for with tax-free 529 withdrawals. However, as with the AOTC, this expanded incentive is temporary and applies only through 2010 (unless Congress extends this tax break). However, tax-free withdrawals can not be taken for computer software designed for games, sports or hobbies, unless the software is “predominantly educational in nature.”

 Caution. While the tax law allows you to combine the tax benefits of a 529 plan with one of the education credits or deductions, you cannot “double dip.” That is, the expenses you use to compute the AOTC (or Lifetime Learning Credit) cannot also be included as a qualified higher education expense for purposes of determining your tax exclusion for 529 plan withdrawals.

Remember, too, that states have their own rules regarding education benefits, such as withdrawals from 529 plans. These must be considered as part of your education tax savings strategy.

 Student loan interest deduction

 Eligible individuals can take an above-the-line deduction for up to $2,500 of interest paid on student loans used to pay for the cost of attending any college, university, vocational school, or graduate school. A student loan, for purposes of the deduction, is a loan you took out and is designated solely to pay your (or your spouse’s or dependent’s) qualified education expenses. For example, if you take out a home equity loan to pay for college tuition, the interest may be deductible as mortgage interest, but it is not considered above-the-line interest for a student loan since the lender did not specifically restrict the proceeds to education expenses.

 Good news on student loan interest, however, is that qualified education expenses include not only tuition and fees, but also room and board, books, supplies and equipment, and other necessary expenses such as transportation. Interest paid on a loan that is made to you by a related person, such as parents or grandparents, or from a qualified employer plan do not qualify for the deduction.

 The deduction is available regardless of whether or not you itemize. The amount of the deduction begins to phase out when an individual’s modified AGI exceeds $55,000 a year (or $115,000 for married couples filing jointly). The deduction is completely eliminated once an individual’s modified AGI reaches $70,000 (or $145,000 for joint filers). If you are claimed as a dependent on another’s tax return, you can not take the deduction, however.

 Expired incentives hanging in the wings

 At the end of 2009, two popular, but temporary, tax incentives expired: the higher education tuition deduction and the teachers’ classroom expense deduction of up to $250. Congress is working on legislation to extend these benefits through 2010. We will keep you posted on its progress.

 Please contact us to discuss the higher education tax saving strategies that can benefit your particular situation.

The health care reform package (the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010) imposes a new 3.8 percent Medicare contribution tax on the investment income of higher-income individuals. Although the tax does not take effect until 2013, it is not too soon to examine methods to lessen the impact of the tax.

Net investment income

"Net investment income" includes interest, dividends, annuities, royalties and rents and other gross income attributable to a passive activity. Gains from the sale of property not used in an active business and income from the investment of working capital are also treated as investment income. Further, an individual's capital gains income will be subject to the tax. This includes gain from the sale of a principal residence, unless the gain is excluded from income under Code Sec. 121, and gains from the sale of a vacation home. However, contemplated sales made before 2013 would avoid the tax.

The tax applies to estates and trusts, on the lesser of undistributed net income or the excess of the trust/estate adjusted gross income (AGI) over the threshold amount ($11,200) for the highest tax bracket for trusts and estates, and to investment income they distribute.

However, the tax will not apply to nontaxable income, such as tax-exempt interest or veterans' benefits.

Deductions

Net investment income is gross income or net gain, reduced by deductions that are "properly allocable" to the income or gain. This is a key term that the Treasury Department expects to address in guidance, and which we will update on developments. For passively-managed real property, allocable expenses will still include depreciation and operating expenses. Indirect expenses such as tax preparation fees may also qualify.

For capital gain property, this formula puts a premium on keeping tabs on amounts that increase your property's basis. It also focuses on investment expenses that may reduce net gains: interest on loans to purchase investments, investment counsel and advice, and fees to collect income. Other costs, such as brokers' fees, may increase basis or reduce the amount realized from an investment. As such, taxpayers may want to consider avoiding installment sales with net capital gains (and interest) running past 2012.

Thresholds

The tax applies to the lesser of net investment income or modified AGI above $200,000 for individuals and heads of household, $250,000 for joint filers and surviving spouses, and $125,000 for married filing separately. MAGI is your AGI increased by any foreign earned income otherwise excluded under Code Sec. 911; MAGI is the same as AGI for someone who does not work overseas.

Example. Jim, a single individual, has modified AGI of $220,000 and net investment income of $40,000. The tax applies to the lesser of (i) net investment income ($40,000) or (ii) modified AGI ($220,000) over the threshold amount for an individual ($200,000), or $20,000. The tax is 3.8 percent of $20,000, or $760. In this case, the tax is not applied to the entire $40,000 of investment income.

Exceptions to the tax

Certain items and taxpayers are not subject to the 3.8 percent Medicare tax. A significant exception applies to distributions from qualified plans, 401(k) plans, tax-sheltered annuities, individual retirement accounts (IRAs), and eligible 457 plans. There is no exception for distributions from nonqualified deferred compensation plans subject to Code Sec. 409A. However, distributions from these plans (including amounts deemed as interest) are generally treated as compensation, not as investment income.

The exception for distributions from retirement plans suggests that potentially taxable investors may want to shift wages and investments to retirement plans such as 401(k) plans, 403(b) annuities, and IRAs, or to 409A deferred compensation plans. Increasing contributions will reduce income and may help you stay below the applicable thresholds. Small business owners may want to set up retirement plans, especially 401(k) plans, if they have not yet established a plan, and should consider increasing their contributions to existing plans.

Another exception is provided for income ordinarily derived from a trade or business that is not a passive activity under Code Sec. 469, such as a sole proprietorship. Investment income from an active trade or business is also excluded. However, SECA (Self-Employment Contributions Act) tax will still apply to proprietors and partners. Income from trading in financial instruments and commodities is also subject to the tax.

The additional 3.8 percent Medicare tax does not apply to income from the sale of an interest in a partnership or S corporation, to the extent that gain of the entity's property would be from an active trade or business. The tax also does not apply to business entities (such as corporations and limited liability companies), nonresident aliens (NRAs), charitable trusts that are tax-exempt, and charitable remainder trusts that are nontaxable under Code Sec. 664.

Income tax rates

In addition to the tax on investment income, certain other tax increases proposed by the Obama administration may take effect in 2011. The top two marginal income tax rates on individuals would rise from 33 and 35 percent to 36 and 39.6 percent, respectively. The maximum tax rate on long-term capital gains would increase from 15 percent to 20 percent. Moreover, dividends, which are currently capped at the 15 percent long-term capital gain rate, would be taxed as ordinary income. Thus, the cumulative rate on capital gains would increase to 23.8 percent in 2013, and the rate on dividends would jump to as much as 43.4 percent. Moreover, the thresholds are not indexed for inflation, so more taxpayers may be affected as time elapses.

Please contact our office if you would like to discuss the tax consequences to your investments of the new 3.8 percent Medicare tax on investment income.

• President Biden has proposed investing $80 billion in new technology and more auditors to increase tax collections by $700 billion over 10 years.

• Democrats in Congress contend that funding the IRS and collecting more taxes already owed are key to generating revenue and enforcing the tax code.
• Due to a lack of funding, the number of IRS revenue agents has fallen by nearly a third over the past decade and audit rates for taxpayers who earn more than $1 million a year fell by half between 2010 and 2018, according to the IRS.

President Joe Biden has proposed investing $80 billion in new technology and more auditors to increase tax collections by $700 billion over 10 years. IRS Commissioner Charles Rettig testified before Congress in April that the “tax gap” -- or amount of taxes owed that go unpaid each year -- could be as high as $1 trillion due to cryptocurrency, offshoring and underreporting of income. IRS data from 2011 to 2013 estimated the tax gap at $441 billion a year.

In an interview Thursday on CNBC’s “Squawk Box,” Republican Representative, Kevin Brady, the top GOP member of the House Ways and Means Committee, said Republicans “want to close the tax gap.” But he said the president’s proposal and similar legislation introduced in Congress aimed at beefing up IRS enforcement is flawed.

“This proposal is based on an unfounded issue, which is ‘what is the tax gap?’” he said. “The IRS will admit their data is 7 years old. They’re guessing about crypto currencies and foreign transactions. What they’re saying is give us a ton of money, let’s hire a bunch of auditors and we think this will create revenue. But we’ve seen already one of the problems is, it’s not going to create that revenue.”

Instead, Brady proposed a “thorough analysis” of the tax gap and what’s causing it. “Then together let’s direct the solutions to the problem.”

Democrats in Congress contend that funding the IRS and collecting more taxes already owed are key to generating revenue and enforcing the tax code. Due to a lack of funding, the number of IRS revenue agents has fallen by nearly a third over the past decade and audit rates for taxpayers who earn more than $1 million a year fell by half between 2010 and 2018, according to the IRS.

Howard Gleckman, senior fellow at the Urban-Brookings Tax Policy Center, said one reason the IRS’ published data on the tax gap may be outdated is because Congress has reduced IRS funding. “One thing the IRS could do with more funding is publish the more current data about the tax gap that Mr. Brady wants,” he said.

Gleckman said even if the tax gap is half the IRS estimates, which is unlikely given lower audit rates, “does that mean Congress should not give the IRS the resources it needs to be sure that people pay the taxes they owe?”     

Some Republicans have contended in the past that the IRS should collect existing taxes before Democrats discuss raising tax rates. During the Trump administration, Treasury Secretary Steven Mnuchin said “fixing the tax gap” was one of his top priorities and he pushed for more funding to improve audits on the wealthy.

In response to the Biden plan, many Republican leaders and lower-tax advocates say the IRS is ineffective, overly intrusive and overly political -- as proven, they say, by the tax data on wealthy taxpayers obtained by ProPublica. The investigative news site began publishing a series of articles in June showing how billionaires like Jeff Bezos, George Soros and others pay lower tax rates -- and in some cases no taxes in certain years -- due to loopholes in the tax system. ProPublica says it does not know the anonymous source of the IRS tax data.

Brady said that even with more funding, the IRS hasn’t proven it has the ability to close the tax gap.

“The truth is, the IRS does not have a good record on smart auditing and smart recovery,” Brady said.

A provision in early versions of the bipartisan infrastructure bill included funding to boost IRS collections by an estimated $100 billion over 10 years to help pay for the infrastructure projects. The provision was stripped from the bill due to opposition from Republican negotiators. It will now likely be rolled into the broader reconciliation bill being pushed by Democrats.