These Taxing Times

As I reported in my post of December 17, the recently passed and signed tax act contained an extension for two years (i.e., 2010 and 2011) of the provision that permits tax-free distributions to charity from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer, per taxable year. Since the law was passed so late in the year, a special provision in the Act allows individuals to make “qualified charitable distributions” during January of 2011 and treat them as if made during 2010.

The “Technical Explanation of the Revenue Provisions Contained in the “Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010” prepared by the Joint Committee on Taxation contains the following statement: “Thus, a qualified charitable distribution made in January 2011 is permitted to be (1) treated as made in the taxpayer’s 2010 taxable year and thus permitted to count against the 2010 $100,000 limitation on the exclusion, and (2) treated as made in the 2010 calendar year and thus permitted to be used to satisfy the taxpayer’s minimum distribution requirement for 2010.”

According to the Wall Street Journal, IRS spokesman Eric Smith issued the following statement on January 5: "Required minimum distributions (RMD) from an IRA received by a taxpayer cannot be rolled over to an IRA. As noted on page 24 of the 2009 IRS Publication 590, Individual Retirement Arrangements, ‘Amounts that must be distributed during a particular year under the required distribution rules are not eligible for rollover treatment.’ Moreover, there’s no provision in the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act Of 2010, nor any hint in the Committee report for such RMD recontribution."

While it seems confusing as to whether a January 2010 direct IRA charitable contribution can qualify as a 2010 required minimum distribution, here is my interpretation of these seeming confusing provisions:

• A taxpayer who took a required minimum distribution in 2010 cannot now write a check in January of 2011 to a charitable organization for the amount of that RMD (assume $100,000) and thereby make the amount of that 2010 RMD non-taxable for 2010. The “charitable rollover” must be a direct transfer from the IRA custodian to the charity.
• A taxpayer who was required to take an RMD (assume $100,000) in 2010, but failed to do so may request a qualified charitable distribution from the IRA custodian payable directly to a charitable organization in January of 2011, treat it as a qualified charitable distribution in 2010, and (based on the language of the Technical Explanation) have that distribution treated as a non-taxable RMD for 2010.
• A taxpayer who took a $100,000 taxable RMD in 2010 may now request a $100,000 qualified charitable distribution from the IRA custodian payable directly to a charitable organization in January of 2011, and treat it as an additional 2010 IRA distribution that is not taxable in his 2010 return. This means that the taxpayer took two $100,000 distributions from his IRA applicable to 2010, the first of which was taken during 2010 and was taxable, and the second of which was taken in January of 2011 as a non-taxable qualified charitable distribution for 2010. This additional distribution for 2010 (taken in 2011) does not relieve the taxpayer of taking a required minimum distribution (assume $100,000) in 2011. The taxpayer may, however, take this RMD for 2011 as a qualified charitable distribution, and it will not be taxable in his 2011 tax return. Thus, the taxpayer has taken one $100,000 taxable distribution from his IRA and two $100,000 qualified charitable distributions, one of which must occur in January of 2011.

Note that this confusion would simply have not arisen had Congress responsibility extended the charitable rollover provisions for 2010 and 2011 in December of 2009, which it could have easily done.

Remember, as confusing as these provisions may be, they apply only to distributions from traditional or Roth IRAs. They do not apply to distributions from a section 401(k) plan or a qualified pension plan. If you have questions about qualified charitable distributions from your IRA email me at response @phdcpa.com.

Ronnie

Copyright 2011 Ronnie C. McClure, PhD, CPA

Wow, the Internal Revenue Service is really on top of things. The Service today released instructions to help employers implement the 2011 cut in payroll taxes enacted by Congress last night and signed by the President this afternoon, along with new income-tax withholding tables that employers will use during 2011. The following information is taken from an IRS news release that came out this afternoon.

Employers should start using the new withholding tables and reducing the amount of Social Security tax withheld as soon as possible in 2011 but not later than January 31, 2011. Notice 1036, released today, contains the percentage method income tax withholding tables, the lower Social Security withholding rate, and related information that most employers need to implement these changes. Publication 15, (Circular E), Employer’s Tax Guide, containing the extensive wage bracket tables that some employers use, will be available on the Service’s website, IRS.gov, in a few days.

The Service recognizes that the late enactment of these changes makes it difficult for many employers to quickly update their withholding systems. For that reason, the Service asks employers to adjust their payroll systems as soon as possible, but not later than January 31, 2011.

For any Social Security tax over withheld during January, employers should make an offsetting adjustment in workers’ pay as soon as possible but not later than March 31, 2011.

Employers and payroll companies will handle the withholding changes, so workers typically won’t need to take any additional action, such as filling out a new W-4 withholding form.

If you need a copy of Notice 1036 and have trouble getting it, please contact me at response@phdcpa.com and I’ll forward it to you.

Ronnie

Copyright 2010 Ronnie C. McClure, PhD, CPA

The deed is done. Last night the House of Representatives by a vote of 277-148 passed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 without amendment. The Act now goes to the President for signature.

I summarized the Act for you in my post earlier this week. What surprised me about passage is that the $5 million estate tax exemption and the 35% estate and gift tax rate made it through without reduction.

Remember, though, the Act extends tax rates and the enhanced transfer tax system for only two years. We’ll most likely be back in the kettle of not knowing the state of our tax law at this same time in 2012. Also, some of the “extenders” of expiring provisions only apply through 2011. Over the next few weeks I’ll analyze certain parts of the Act and suggest tax planning opportunities for you.

Ronnie

Copyright 2010 Ronnie C. McClure, PhD, CPA

The deed is done. Last night the House of Representatives by a vote of 277-148 passed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 without amendment. The Act now goes the President for signature.

I summarized the Act for you in my post earlier this week. What surprised me about passage is that the $5 million estate tax exemption and the 35% estate and gift tax rate made it through without reduction.

Remember, though, the Act extends tax rates and the enhanced transfer tax system for only two years. We’ll most likely be back in the kettle of not knowing the state of our tax law at this same time in 2012. Also, some of the “extenders” of expiring provisions only apply through 2011. Over the next few weeks I’ll analyze certain parts of the Act and suggest tax planning opportunities for you.

Ronnie

Copyright 2010 Ronnie C. McClure, PhD, CPA

As you know, I send these newsletters out when I feel there have been changes in tax law significant enough to warrant the attention of my clients and friends. While the health care legislation earlier this year contained sweeping tax provisions, my assessment was that with 2014 effective dates, there was no use in being particularly concerned about them at that point. With Congressional and Presidential elections in 2012, a plan to repeal or significantly amend the health care legislation, and having already had parts of it declared unconstitutional, I believe my assessment remains correct.

After over a year of total default by Congress to take action on tax important matters, things are beginning to move fast as the year closes. It is important that they do so because of the significant income tax rate increases and the re-imposition of a burdensome transfer tax system scheduled to become effective January 1. The President cut a deal with Republicans to force relief before Congress adjourns for the year because he knew that he could get a better deal now than he could with a Republican controlled House and only narrow Democratic control of the Senate in just a few weeks. It was a gamble that he has to win, and he’ll probably do so for the most part. Many provisions of the deal could significantly affect your year-end income and transfer tax planning.

While the final vote won’t come until later this month, here’s a not-so-brief summary of what we know at this point based on the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the proposal) introduced in the House and Senate this week:

• Current tax rates and brackets will be extended through 2012 (yes, even for the wealthy taxpayers with adjusted gross income in excess of $250,000; that’s going to be tough for House Democrats to swallow, but my bet is, swallow they will).
• Suspension of the personal exemption phaseout, suspension of the itemized deduction limitation, and the current favorable tax rates applicable to capital gains and dividends will all remain through 2012.
• The current child tax credit, marriage penalty relief for the standard deduction, the 15 percent income tax bracket, earned income credit, current expanded dependent care credit provisions, increased adoption tax credit and the adoption assistance programs exclusion currently in effect, credit for employer expenses for child care assistance, expanded exclusion for employer-provided educational assistance, and expanded student loan interest deduction, exclusion from income of amounts received under certain scholarship programs, and the American Opportunity Tax Credit (for higher education expenses) will all be extended through 2012.
• Extension of bonus depreciation. Congress allowed businesses, beginning January 1, 2008 through December 31, 2009, (later extended through the end of 2010) to take an additional depreciation deduction allowance equal to 50 percent of the cost of the depreciable property placed in service in those years. The proposal extends and temporarily increases this bonus depreciation; for investments placed in service after September 8, 2010 and through December 31, 2011, the bill provides for 100 percent bonus depreciation. For investments placed in service after December 31, 2011 and through December 31, 2012, the bill provides for 50 percent bonus depreciation. The provision also allows taxpayers to elect to accelerate some AMT credits in lieu of bonus depreciation for taxable years 2011 and 2012.
• The alternative minimum tax system (the infamous AMT; Congress’ embarrassment tax) is patched for 2010 and 2011. The proposal also allows the nonrefundable personal credits against the AMT.

Two of the most publicized parts of the proposal provide a Temporary (one year) Extension of Unemployment Insurance and a Temporary (2011 only) Employee Payroll Tax Cut. These are popular and will pass.

The Act also extends some expiring tax benefits for energy and for individuals. The individual extensions include:

• The $250 above-the-line tax deduction through 2011 for teachers and other school professionals for expenses paid or incurred for certain supplies and materials used in the classroom.
• The deduction for State and local general sales taxes through 2011.
• An extension through 2011 of provision encouraging contributions of capital gain real property for conservation purposes.
• An extension through 2011 of the above-the-line tax deduction for qualified education expenses.
• The deduction for premiums for mortgage insurance as qualified residence interest through 2011.
• An extension for two years (i.e., 2010 and 2011) of the provision that permits tax-free distributions to charity from an Individual Retirement Account (IRA) of up to $100,000 per taxpayer, per taxable year. The proposal allows individuals to make charitable transfers during January of 2011 and treat them as if made during 2010. This is favorable, but as currently proposed, would not apply to otherwise qualifying taxpayers who have already taken their required minimum distributions for 2010 and who would have made IRA charitable gifts of those distributions. There is already a lobbying effort underway to amend this provision to also provide that a taxpayer who makes a direct cash gift to a qualified charity in January 2011 be able to elect to have that gift be deemed to be a gift from his or her minimum required distribution taken in 2010 and, to the extent so elected, will not be a taxable minimum required distribution to the taxpayer on his or her 2010 income tax return. We’ll just have to watch and see where this goes.
• The proposal extends through 2011 the increase in the monthly exclusion for employer-provided transit and vanpool benefits to that of the exclusion for employer-provided parking benefits.

Expiring business provisions that would be extended include:

• The business research tax credit through 2011.
• The employer wage credit for activated military reservists through 2011.
• The special 15-year cost recovery period for certain leasehold improvements, restaurant buildings and improvements, and retail improvements through 2011.
• Seven year straight line cost recovery period for motorsports entertainment complexes through 2011.
• Enhanced charitable deduction for contributions of food inventory, contributions of book inventories to public schools, and corporate contributions of computer equipment for educational purposes through 2011.
• The proposal extends for two years (through 2011) the provision allowing S corporation shareholders to take into account their pro rata share of charitable deductions even if such deductions would exceed such shareholder’s adjusted basis in the S corporation.
• The exclusion of small business capital gains. This is significant. Generally, non-corporate taxpayers may exclude 50 percent of the gain from the sale of certain small business stock acquired at original issue and held for more than five years. For stock acquired after February 17, 2009 and on or before September 27, 2010, the exclusion is increased to 75 percent. For stock acquired after September 27, 2010 and before January 1, 2011, the exclusion is 100 percent and the AMT preference item attributable for the sale is eliminated. The provision extends the 100 percent exclusion of the gain from the sale of qualifying small business stock that is acquired before January 1, 2012 and held for more than five years.

With respect to the transfer tax system, the proposal provides:

• An estate tax exemption of $5 million per person and $10 million per couple with a top tax rate of 35 percent for the estate, gift, and generation skipping transfer (GST) taxes through 2012. The exemption amount is indexed beginning in 2012.
• Significantly, these provisions are effective retroactive to January 1, 2010, but allow a decedent’s estate an election to choose no estate tax and modified carryover basis (as currently in effect for 2010) for estates arising on or after January 1, 2010 and before January 1, 2011.
  
• A $5 million generation-skipping transfer tax exemption and zero percent rate for 2010. Under the law currently in effect for 2010, there was no generation-skipping tax and the amount that could be transferred tax-free was unlimited. What this provision seems to do is eliminate the use of a $5 million GST exemption in future years, even though GST transfers made in 2010 will not bear tax.
• “Portability” of a decedent’s unused exemption. Under current law, couples have to do complicated estate planning (known as “credit shelter” or “bypass” trusts) to claim their entire joint exemption (currently $3.5 million each, $7 million for a couple). The proposal allows the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without such planning. The proposal is effective for estates of decedents dying after December 31, 2010. Personally, I’m not sure this is a good idea. There will be potential problems with a transferred exemption amount in the case of the surviving spouse’s remarriage. Plus, credit shelter trusts gives the first-to-die greater certainty of the ultimate disposition of his credit shelter amount upon the death of his or her surviving spouse. I’m going to continue to recommend this type of trust for my clients.
• Reunification of the estate and gift tax provisions. Prior to a change in the law in 2001, the estate and gift taxes were unified in a single transfer tax system, creating a single graduated rate schedule for both. That single lifetime exemption could be used for gifts and/or bequests. The 2001 law change decoupled these taxes and set a separate exemption amount for lifetime gifts. The proposal reunifies the estate and gift taxes effective for gifts made after December 31, 2010. This is good.

It is on these transfer tax changes that I believe House Democrats are going to gag. Almost having to accept lower income tax rates for the wealthy through 2012, I believe the Democrats will rebel against a higher transfer tax exemption, and lower rates for those estates to which wealth transfer taxes will apply. I predict the Republicans will have to compromise here and accept the $3.5 million exemption and 45% tax rate that were in place for 2009. I anticipate that the portability and reunification proposals will remain, but they could be shot down, too.

Notice that most of these provisions will expire immediately following the Congressional and Presidential elections in 2012. We are going to be in the same or worse shape then than we are now. We won’t know the ultimate outcome of these 2010 changes until very late in 2012 or early 2013.

Whew, that’s a lot to digest. And, that’s not all that’s in the proposal, but enough for you to consider now. I will follow up over the coming weeks with a synopsis of what actually passes and provide greater detail. If you have questions as to how these provisions will affect you, please contact me at response@phdcpa.com or call me at 214.957.3366.

Ronnie

Copyright 2010 Ronnie C. McClure, PhD, CPA