These Taxing Times

In a separate post, which most of you have received, I have published a brief summary of the recently enacted American Recovery and Reinvestment Tax Act of 2009 (also known as the Stimulus Act) as it applies to individuals. This post will summarize the provisions of the Act applicable to businesses. I will follow this with others going into somewhat more detail for each of these provisions.

• The favorable 50% bonus depreciation deduction now applies for property acquired after December 31, 2007 and placed in service during 2009 (and 2010 in the case of certain longer-lived and transportation property). Taxpayers having unused AMT or research credits may elect to accelerate these credits in lieu of taking bonus depreciation.
• The “Section 197” election for a business taxpayer to expense property purchases was due to be reduced to $125,000 for 2009. The $250,000 amount available for 2008 has now been extended and covers equipment purchased in tax years beginning in 2009. The other limitations to use of the maximum section 179 deductions are basically unchanged.
• The Internal Revenue Code has for years contained a provision that allowed a current year net operating loss (NOL) of a business to be carried back to the two immediately preceding tax years in order to effect an immediate tax refund for taxes paid in those years. Any remaining NOL did not disappear, but could be carried forward for an additional 20 years following the loss year. Certain extended carryback provisions applied to certain disaster areas and industries. The Act has modified the NOL carryback provisions by adding additional, elective, carryback periods for small businesses. A small business is defined as one have a three-year average of less than $15,000,000 in gross receipts. Electing small businesses may now elect to carry a 2008 or 2009 loss back as far as five years. However, if more beneficial, the taxpayer may also elect to carryback only as far as the fourth or third years preceding 2008. Careful, this is a one-time election and may require significant planning to produce the maximum tax refund (that is, you can only make the longer carryback election for losses incurred in 2008 or 2009, but not both 2008 and 2009). Note that this provision may be applicable to 2008 tax returns currently being prepared.
• Here’s a change that is applicable to “qualified” individuals, estates, and trusts making estimated tax payments in 2009 and having business income from “small” sole proprietorships, S corporations, and partnerships in 2008. Under present law, the required annual estimated payment was to have been the lesser of 90 percent of the actual tax on their 2009 return or 100 percent (110 percent for 2008 AGI of more than $150,000) of the tax shown on their 2008 return. This 100 or 110 percent amount has been reduced to 90 percent. A “qualified” person is one whose AGI in 2008 did not exceed $500,000 ($250,000 if married and filing separately) and who certifies that more than 50 percent of their 2008 gross income came from a “small business.” The Service will issue regulations as to how a taxpayer makes this certification. For this purpose, a “small business” means a trade or business having an average of less than 500 employees in 2008.
• The law currently contains a “work opportunity tax credit” for up to 40 percent of “qualified first-year wages” (generally providing a credit not exceeding $2,400 per new employee) paid to members of certain targeted groups. The classes of targeted groups have been expanded to include “unemployed veterans” and “disconnected youth” hired in 2009 or 2010. I’ll expand this explanation, including definitions, in a future post.
• Regular “C” corporations, or any person involved with a trade or business, who “reacquires” outstanding business debt for less than the remaining balance of that debt is required to recognize “discharge of indebtedness” income. In other words, you must take into income the amount you no longer have to repay. One reacquires outstanding debt by paying it off, renegotiating the note with the lender, or issuing new debt in place of the old. Typically, this income is recognized in the year of cancellation. Under the Act, a taxpayer may elect to recognize income resulting from forgiveness of business debt in 2009 or 2010 ratably over five years beginning in 2014. This spreads the income hit equally over tax years 2014 – 2018. Note: this applies to business debt only, not personal mortgage indebtedness. That may be the subject of separate legislation.
• Under present law, non-corporate taxpayers may exclude from income 50 percent of any gain resulting from the sale or exchange of “qualified small business” stock held for five years. In the case of such stock acquired after February 17, 2009 and before January 1, 2011, the Act raises the amount excludable to 75 percent. The bad news is that the five-year holding period still applies. Taxpayers will not realize any benefit from this provision for sales of such stock before February 17, 2014. A “qualified small business” is a C corporation with assets of less than $50 million.
• S corporations that once were regular C corporations are subject to a special “built-in gains tax” for 10 years on any realized gain (including goodwill) that arose in their C corporation tax years. This produces “double tax” (once to the corporation, again to the shareholders) for that gain. For tax years beginning in 2009 and 2010, this 10-year period is reduced to 7 years. If it makes good business sense, S corporation with appreciated assets from C corp years more than 7 years ago may want to dump those assets in 2009 or 2010 and be taxed only once (at the shareholder level) on such gains.

These are the only provisions applicable to most businesses. There are other provisions applicable to particular industries, tax-exempt bonds, and energy incentives. I’ll flesh out later the provisions I have summarized above. In the meantime, if you have any questions, please email or call me.

Ronnie

Copyright 2009 Ronnie C. McClure, PhD, CPA

It has been hard to write about the recently enacted American Recovery and Reinvestment Act of 2009 (the Stimulus Bill), because it is so terribly disappointing. I didn’t like it when I first read it, neither the market nor the public liked it, and the more I read it, the more disappointed I am. Any stimulus to the economy is likely going to be first realized by money the Act gives to the states to keep them afloat and to spend on infrastructure repair and replacement. I trust this will create new employment before the end of the year.

So much for venting (for now). There’s a lots to not like, but let me quickly summarize the tax provisions – which do little – applicable to individuals. I will supplement this summary with additional information over the next few days concerning specific parts of the tax legislation. I will have different posts for individuals and businesses. I will also do a business summary similar to this one. First, understand that the Stimulus Act is in two parts (Parts A and B). Within the Act’s 1,071 pages (my copy, which is the hand-marked up, margin-annotated version of the conference committee bill) are numerous titles and subsections that carry their own names, leading one to believe they were separate pieces of legislation (they probably were once, and have been lying around the House for years). The tax title, in Part B, is known as the American Recovery and Reinvestment Tax Act of 2009. Here’s the brief summary applicable to individuals in this section of the Act:

• You’ve heard about the much-touted Making Work Pay Credit, which is to give each individual a maximum $400 ($800 for joint filers) tax reduction in 2009 and again in 2010. You’ll get this through reduced income tax withholding ($400/52 equals about $8 per week) beginning sometime later this year. If your adjusted gross income (AGI) exceeds $75,000 ($150,000 for joint filers), you’ll have to pay some or all of it back when you file your 2009 tax return.
• The Earned Income Tax Credit is increased for 2009 and 2010, particularly for taxpayers with three or more children. Those taxpayers may now claim a maximum credit of about $5,656. The credit phases out for all taxpayers above a certain earned income level regardless of the number of children and is completely phased out at $35,463 of earnings ($40,463 if married filing jointly).
• Current law provides that individuals with children below the age of 17 (24 for students) may be entitled to a Child Tax Credit of $1,000 per child. The credit is phased out above AGIs of $110,000 (married filing jointly), $75,000 (unmarried individuals) and $55,000 (married filing separately). If the credit exceeds the taxpayer’s tax liability, a portion of the credit may be refunded. The new Act increased the refundable amount.
• The Hope Scholarship Credit has been modified (by adding a new American Opportunity Tax Credit) for 2009 and 2010. The maximum credit is now $2,500 of college tuition and related expenses. Related expenses now include course materials. The credit is now available during the student’s first four (up from two) years of college. The modified credit is phased out for taxpayers with adjusted gross income between $80,000 and $90,000 ($160,000 and $180,000 for married taxpayers filing a joint return). The modified credit may be claimed against a taxpayer’s alternative minimum tax liability. A portion of the credit may be refundable if it exceeds the taxpayer’s tax liability.
• Computer equipment, Internet access and related services (not games) may now be funded from a section 529 qualified tuition account if the technology, equipment, or services are to be used by the beneficiary and family while the beneficiary is enrolled at an eligible educational institution.
• The Act extends the existing refundable “first-time” homebuyer tax credit for qualifying home purchases completed before December 1, 2009, increases the maximum credit amount to $8,000 ($4,000 for a married individual filing separately), and waives recapture of the credit for qualifying home purchases after December 31, 2008 and before December 1, 2009. A first-time homebuyer is an individual (and spouse) who had no ownership interest in a principal residence in the United States during the three-year period prior to the purchase of the new home. The credit phases out for individual taxpayers with AGI between $75,000 and $95,000 ($150,000 and $170,000 for joint filers) for the year of purchase.
• Under the Act, the first $2,400 of unemployment compensation received in 2009 is not taxable.
• Taxpayers who do not elect to deduct general state sales taxes instead of state income taxes may now be able to deduct sales taxes on certain automobiles, motorcycles, and motor homes with a sales price not to exceed $49,500. This will be of little to no benefit in Texas, for example, since we do not have a state income tax and can already deduct sales taxes. The difference will be that non-itemizers may also claim the deduction. This deduction begins to phase out at AGI of $125,000 ($250,000 in the case of a joint return), and is completely phased out at AGI of $135,000 ($260,000).
• The alternative minimum tax is patched for 2009, so we don’t have to wait until November or December to face that. At some point, Congress is going to have to address the whole AMT tax system.

That’s about it for individual tax changes. I will next post a summary of business provisions, and then expand on both individual- and business-specific provisions. In the meanwhile, call or email me if you have questions.

Ronnie

Copyright 2009 Ronnie C. McClure, PhD, CPA

As this is being written, the House and Senate are considering compromise economic stimulus legislation. The result may be available later this week. While I have been monitoring the separate bills as they have progressed through Congress, I have not cluttered your inbox with the proposals. As soon as a compromise bill is sent to the president, I will begin reporting its significant tax provisions and tax planning opportunities to you.

In the meantime, the Internal Revenue Service recently called attention to the Treasury’s recently updated Report of Foreign Bank and Financial Accounts (FBAR). I wanted to share this with you, because failure to file this report can have serious consequences.

All of the major tax returns (individual, corporation, partnership, trust and estate) or their attached schedules ask, “At any time during the year, did you (or the corporation, partnership, trust or estate) have an interest in or a signature or other authority over a financial account in a foreign country, such as a bank account, securities account, or other financial account?” Many taxpayers simply check “Yes” and answer a question reporting the country or countries in which the accounts are held. The reporting requirement, however, does not end there. If the answer is yes, the taxpayer is required to separately file Form TD F 90-22.1 (Report of Foreign Bank and Financial Accounts). The FBAR is not attached to the tax return and is typically not prepared as part of the regular tax return preparation process.

Any United States person who has a financial interest in or signature authority, or other authority over any financial account in a foreign country, is required to file if the aggregate value of these accounts exceeds $10,000 at any time during the calendar year.

A FBAR is filed by June 30 of the year following the year that the account holder meets the $10,000 threshold with the U.S. Department of the Treasury, P.O. Box 32621, Detroit, MI 48232-0621. An extension of time to file Federal income tax returns does not extend the due date for filing an FBAR. There is no extension available for filing this form. A FBAR must be filed whether or not the foreign account generates any income.

Penalties for failure to file may be severe. A “non-willful” failure to file may result in a civil penalty up to $10,000 for each negligent violation. An additional civil penalty of up to $50,000 for each negligent violation may be assessed if there is a pattern of negligent activity. Willful failure to file FBARs or to retain records of the accounts may result in a civil penalty of the greater of $100,000 or 50 percent of the value of the account, and criminal penalties of $250,000, a 5-year prison term, or both. OUCH!

If you learn you were required to file FBARs for earlier years, you should file the delinquent FBAR reports and attach a statement explaining why the reports are filed late. The Service will assess no penalty if it determines that the late filings were due to reasonable cause.

As with any other aspect of tax law, definition of terms is important. I haven’t attempted to define terms in this short communication, but if you have any questions concerning FBARs, contact me at 214.957.3366 or email me.

Ronnie

Copyright 2009 Ronnie C. McClure, PhD, CPA

The Internal Revenue Service recently issued a fact sheet regarding shareholder-employee compensation from an S corporation. Tax advisors commonly advise S corporation shareholder-employees to pay themselves minimum compensation in the form of “wages” subject to Social Security and Medicare taxes, and take the rest of their compensation as “distributions” not subject to federal employment taxes. Remember, too, that the term “wages” includes all remuneration for employment, such as the cash value of all benefits. The fact sheet cautions that, “S corporations should not attempt to avoid paying employment taxes by having their officers treat their compensation as cash distributions, payments of personal expenses, and/or loans rather than as wages.” This is an area of serious contention between the Service and S corporation shareholders and their attorneys.

Generally, shareholder is an employee of a corporation if he or she performs more than nominal services for the corporation. The Treasury Regulations provide an exception for an officer of a corporation who does not perform any services or performs only minor services and who neither receives nor is entitled to receive, directly or indirectly, any remuneration. Such an individual would not be considered an employee.

Instructions to the Form 1120S (U.S. Income Tax Return for an S Corporation), state, “Distributions and other payments by an S corporation to a corporate officer must be treated as wages to the extent the amounts are ‘reasonable compensation’ for services rendered to the corporation.” The obvious issue is, “What is reasonable compensation for a shareholder-employee?” Neither the Internal Revenue Code nor the Treasury regulations define the term. Various courts have defined “reasonable compensation” based on the facts and circumstances of each case, based on some of the facts below:

• Training and experience
• Duties and responsibilities
• Time and effort devoted to the business
• Dividend history
• Payments to non-shareholder employees
• Timing and manner of paying bonuses to key people
• What comparable businesses pay for similar services
• Compensation agreements
• The use of a formula to determine compensation

Under current law, wages of less than $106,800 coupled with high distributions will certainly raise “reasonable comp” questions with the Service. That amount is the FICA limit in 2009 subject to the 12.4 social security tax; amounts above that are only subject to the 2.9 percent health insurance tax. This amount should not be considered a “safe harbor,” however.

The fact sheet also addressed treatment of medical insurance premiums paid on behalf of (or reimbursed to) shareholder/employees. It states that “The health and accident insurance premiums paid on behalf of the greater than 2 percent S corporation shareholder-employee are deductible by the S corporation as fringe benefits and are reportable as wages for income tax withholding purposes on the shareholder-employee’s Form W-2. They are not subject to Social Security, Medicare, or Unemployment taxes. Therefore, this additional compensation is included in Box 1 (Wages) of the Form W-2, Wage and Tax Statement, issued to the shareholder, but would not be included in Boxes 3 or 5 of Form W-2. Payments of the health and accident insurance premiums on behalf of the shareholder may be further identified in Box 14 (Other) of the Form W-2.”

All of this may change, however. There is some thought of making S corporation “distributions” subject to self-employment taxes in the same manner as a partnership. While that may cure the problem, the barrier to such legislation is the fact that corporations (including S corporations) are legal entities separate from their owners. I’ll be watching for developments in this area as tax legislation emerges from a new Congress.

If you have questions concerning tax treatment of compensation to owners of S corporations, partnerships, or LLCs, call me at 214.957.3366 or email me.

Ronnie

Copyright 2008 Ronnie C. McClure, PhD, CPA